Is The Citimortgage Opinion Flawed For Not Requiring Proof Of Assignment Documents?

This is my final post about the Indiana Supreme Court’s opinion in Citimortgage v. Barabas, 2012 Ind. LEXIS 802 (Ind. 2012).  Here are my other three:  10-26, 10-19, 10-12.  The Court’s decision to grant Citimortgage’s motion to intervene was understandable in that it preserved the senior lien.  Based upon the Court’s ruling, a logical outcome would have been to set aside the trial court’s judgment and resulting sheriff’s sale.  But that’s not what happened. 

Result.  The Court didn’t simply remand the case to the trial court - to the prejudgment stage - for further proceedings with Citimortgage as a party.  The Court dispensed with a “do over” and instructed the trial court to amend its judgment “to provide that ReCasa took the [real estate] subject to Citimortgage’s lien.”  What I believe this means is that the litigation (for now) is over but that Sanders, the third-party purchaser, owns the real estate subject to the Citimortgage lien (of an undetermined amount).  Junior mortgagee ReCasa didn’t lose – Sanders did

Absence of proof.  A more curious aspect of the Court’s analysis was the fact that there was no hard evidence of Citimortgage’s lien.  From what I can tell in reviewing all of the Citimortgage opinions, there was no proof of the date upon which Citimortgage acquired the lien or, in other words, when Citimortgage became Irwin’s assignee.  The Court appears to have assumed, based perhaps on the 2009 mortgage assignment, that Citimortgage was the mortgagee at the time ReCasa filed the suit in 2008.

Against the grain.  Setting aside the trial court’s judgment is one thing, but it’s an entirely different matter to effectively grant Citimortgage its own judgment.  This outcome seems to cut against law that has developed in this country over the last several years mandating that lenders/mortgagees actually prove that they hold the mortgage at the time of the filing of a foreclosure claim.  As I noted back in November of 2007, a famous opinion from a federal court in Ohio emphatically held that an institution filing a foreclosure suit must have proof that it owned the note and held the mortgage on the date of the filing of the foreclosure complaint.  This means that the real party in interest must produce, and typically must include as exhibits in its pleadings, chain of assignment documents linking the original lender/mortgagee to the holder of the debt at that time.  Without such documentation, the party lacks standing to file a lawsuit or, in the case of a junior lien holder, to assert a claim in a lawsuit, which is what Citimortgage did.  In the Ohio case, District Judge Boyko lectured:  “unlike Ohio State law and procedure, as the Plaintiffs perceive it, the federal judicial system need not, and will not, be forgiving in this regard.”  In footnote 3, he flatly rejected plaintiff’s “judge, you just don’t understand how things work” argument. 

Seemingly, the Indiana Supreme Court bought the “judge, you just don’t understand how things work” argument in Citimortgage.  Or, to be fair, perhaps the Court knows how things work.  Either way, a compelling contrast exists between Judge Boyko’s uncompromising order dismissing plaintiffs’ cases and the Indiana Supreme Court’s pragmatic decision recognizing Citimortgage’s purported lien. 


In Indiana, Name MERS In Foreclosure Suit If Mortgage Does

This follows-up last week’s post regarding the Citimortgage opinion, which circumvented two foreclosure statutes that supported a conclusion opposite of the one the Court reached.  The result preserved the lien rights of the purported senior mortgagee, Citimortgage, even though Citimortgage did not record its assignment of mortgage until months after the subject real estate had been sold at a sheriff’s sale.  How?  Citimortgage had an “ace in the hole” – Mortgage Electronic Registration Systems, Inc. (“MERS”).

Section 1 problem.  The Court wrestled with the applicability of Ind. Code § 32-29-8-1 (“Section 1”), which governs who should be named when a plaintiff seeks to extinguish a mortgage.  That statute currently identifies two options as to whom to sue:

If a suit is brought to foreclose a mortgage, the [1] mortgagee or an [2] assignee shown on the record to hold an interest in the mortgage shall be named as a defendant.

Citimortgage argued that MERS was statutorily entitled to notice under that provision as a “mortgagee.”  The Court stated “that is a bridge too far.”  The Court found that MERS was neither the mortgagee itself nor the assignee of the mortgage.  Yet Citimortgage prevailed.   

Section 1 solution.  The Court plowed new ground by determining that the mortgage designated MERS as the agent of Citimortgage and that MERS as agent was entitled to notice:

Ultimately, we do not believe that the authors of the original version of [Indiana Code § 32-29-8-1], writing in 1877, would have understood the term “mortgagee” to include an entity like MERS that neither holds title to the note nor enjoys a right of repayment.  Thus, our decision here should not be taken to mean that MERS is a “mortgagee” as the term is used in Indiana Code § 32-29-8-1.  All we hold today is that because Citimortgage never received proper notice of the foreclosure proceeding, it lay beyond the jurisdiction of the trial court, and the default judgment is thus void as to Citimortgage’s interest in the Madison County property. 

One might interpret Citimortgage to say that Section 1 includes a third option as to whom to sue:  a nominee (agent) of the mortgagee.

Section 2 problem.  Citimortgage avoided the impact of I.C. § 32-29-8-2(1) (“Section 2”), which states that “a person who is assigned a mortgage and fails to have the assignment properly placed on the mortgage record . . . is bound by the court’s judgment or decree as if the person were a party to the suit.”  At some point, Citimortgage apparently became the assignee of Irwin but evidently did not record the assignment until after ReCasa obtained a judgment (and flipped the house to Sanders).  Yet Citimortgage prevailed. 

Section 2 solution.  The Citimortgage decision carves out an exception to the recording requirement in Section 2 when the mortgage identifies MERS.  The plaintiff must name MERS “as nominee” of the identified lender.  The Court’s rationale appears to be based upon the premise that MERS - identified in the mortgage - is shown on the record to hold an interest in the mortgage.

Statutory amendments coming?  In its opinion, the Court poked Indiana’s legislature about changing I.C. § 32-29-8:

We note in closing that it is both difficult and undesirable to apply such superannuated statues to the modern mortgage industry.  The drafters of the original 1877 version of Indiana Code § 32-29-8-1 envisioned a drama for two, or at most three, actors:  Borrower, Mortgagee, and possibly Assignee.  They could not have imagined our present-day multi-trillion-dollar international mortgage market.  The statute that they drafted, and under which Indiana mortgage transactions still take place, thus leaves unaddressed many issues important to contemporary practice.  We recognize that the General Assembly may soon find it necessary to modernize the statutory script to accommodate this new and larger cast of characters.

How the Indiana General Assembly will tweak Sections 1 or 2, if at all, is guesswork.  Perhaps MERS itself will be written into the statute, or maybe the statute will define “nominee” and add such a party as an option for whom to sue.  Something should be done, and Section 3 should be included in any amendment. 

Name MERS.  What we do know in the wake of Citimortgage is that, under Indiana law, MERS “as nominee” is the actual mortgagee’s agent for service of process.  When a mortgage identifies MERS “as nominee,” the plaintiff creditor must name MERS as a defendant in any foreclosure action and serve MERS with a summons and complaint.  To be safe, both the identified lender and MERS should be named in the suit. 

Next week I’ll address what some may feel to be a flaw with the Court’s ultimate finding.

Indiana Supreme Court Concludes That MERS Is Merely The Agent Of The Actual Mortgagee

What is Mortgage Electronic Registration Systems, Inc. (“MERS”)?  More specifically, what does mortgage language identifying MERS “as nominee” mean?  The Indiana Supreme Court in Citimortgage v. Barabas, 2012 Ind. LEXIS 802 (Ind. 2012) dealt with those and other questions surrounding the role of MERS in the foreclosure world. 

Setting the table.  As noted in my prior posts about Citimortgage, junior mortgagee ReCasa initiated a foreclosure action and named only Irwin, the purported senior mortgagee, as a defendant.  The language in the subject mortgage stated that Barabas, the mortgagor, granted the mortgage to MERS “as nominee” of Irwin, identified as the lender.  Upon being sued to answer as to its interests in the subject real estate, Irwin quickly filed a disclaimer of interest, and the court dismissed Irwin from the case.  The trial court later entered judgment for ReCasa, which acquired the real estate at the sheriff’s sale.  ReCasa then sold the real estate to a third party, Sanders.  A month later, Citimortgage filed a motion to intervene in the action and asked the trial court to set aside the judgment and sheriff’s sale. 

Defining MERS.  In its rationale, the Court came to terms with the reality that “about 60% of the country’s residential mortgages are recorded in the name of MERS rather than in the name of the bank, trust, or company that actually has a meaningful economic interest in the repayment of the debt.”  The Court pronounced that “a MERS member bank appoints MERS as its agent for service of process in any foreclosure proceeding on a property for which MERS holds the mortgage.”  The Court found that:

the relationship between Citimortgage and MERS was one of principal and agent.  Clearly, one of the primary purposes of that agency relationship was to facilitate efficient service of process.  . . .  By designating MERS as an agent for service of process, as Irwin did in the Barabas mortgage, lenders can have their cake and eat it too; they free themselves from burdensome, expensive recording requirements but still receive notice when another lienholder seeks to foreclose on a property in which they have a security interest.

Senior mortgage survives.  The core question in Citimortgage was whether ReCasa’s failure to name MERS as a defendant impacted the rights, if any, of Citimortgage, which at some point appears to have acquired the senior mortgage.  Although the Court of Appeals affirmed the trial court’s decision in favor of ReCasa, the Supreme Court ruled for Citimortgage.  ReCasa’s failure to name MERS as a defendant or, more specifically, failure to serve MERS with a summons and complaint, prevented ReCasa from terminating the senior mortgage and leapfrogging into the first lien position.  In short, the judgment was void as to Citimortgage. 

Next week, I’ll explain how the Court in Citimortgage circumvented two foreclosure statutes that clearly supported ReCasa’s position. 

Post-Sale Redemption Mystery Unsolved

Last week, the Indiana Supreme Court said much about Mortgage Electronic Registrations Systems, Inc. (“MERS”) in Citimortgage v. Barabas, 2012 Ind. LEXIS 802 (Ind. 2012).  The Court also said a lot about who should receive notice of a foreclosure proceeding.  I hope to discuss those matters next week. 

No comment.  Just as important was what Citimortgage didn’t say.  I’m referring to the issue of the enigmatic post-sheriff’s sale statutory right of redemption found at Ind. Code § 32-29-8-3 entitled “Good faith purchaser at judicial sale; right to redeem of assignee or transferee not made a party.”  For background, please click on my August 2 and November 1, 2011 posts regarding Citimortgage.  Subsequently, the Indiana General Assembly amended portions of Section 3, but as I wrote in March of this year the obscure one-year redemption language remained untouched by the legislature.  Here is the statute, and the key language is underlined: 

     Sec. 3. A person who:
        (1) purchases a mortgaged premises or any part of a mortgaged premises under the court's judgment or decree at a judicial sale or who claims title to the mortgaged premises under the judgment or decree; and
        (2) buys the mortgaged premises or any part of the mortgaged premises without actual notice of:
            (A) an assignment that is not of record; or
            (B) the transfer of a note, the holder of which is not a party to the action;
holds the premises free and discharged of the lien. However, any assignee or transferee may redeem the premises, like any other creditor, during the period of one (1) year after the sale or during another period ordered by the court in an action brought under section 4 of this chapter, but not exceeding ninety (90) days after the date of the court's decree in the action.

When the Supreme Court accepted transfer in Citimortgage, many thought the Court would interpret the redemption language in Section 3.  No such luck.  The Court  expressed “no opinion as to whether Citimortgage had the right to redeem the property under [Section 3].”   This is because the Court decided the case on other grounds.  The opinion provided no help with the confusion and uncertainty created by the analysis of the Court of Appeals in Citimortgage, which precedent has now been vacated.

Status.  It’s my understanding Indiana’s legislature may consider clearing up I.C. § 32-29-8-3 in the 2013 session.  For now, while Indiana law is well settled that a sheriff’s sale terminates the right of redemption for borrowers/mortgagors, the law remains unclear as to whether there exists some kind of post-sheriff’s sale right of redemption for mortgage assignees whose assignments were not recorded before the filing of the foreclosure complaint.  As I often say, foreclosing lenders should invest in a foreclosure (title) commitment, and purchasers at sheriff’s sales should buy title insurance. 

NOTE:  In the 2013 session, Indiana's General Assembly deleted much of Section 3(2)(B) so as to resolve the matter once and for all.  My post

Indiana Supreme Court Reverses Trial Court In Landmark Case Involving MERS

Yesterday, the Indiana Supreme Court issued its opinion in Citimortgage v. BarabasClick here to read the case.  I plan on writing about the decision next week and following-up on my 2011 posts regarding the Indiana Court of Appeals' rulings in the dispute:  August 2/time bar, August 10/straw man and November 1/redemption

By rule, the two Court of Appeals' Citimortgage opinions have been vacated in their entirety.  In other words, they are no longer binding precedent in Indiana.  Thus yesterday's decision to a large extent mooted my 2011 posts, particularly because the Supreme Court did not adopt the Court of Appeals conclusions or rationale. 

By way of a preview, MERS appears to be alive and well in Indiana.  The Section 3 post-judgment redemption right, however, may not be.  The Court expressed "no opinion as to whether Citimortage had the right to redeem the property under that statute."  More to come....  

Unreleased Line of Credit Mortgage Lien Negated By Payoff

U.S. Bank v. Seeley, 953 N.E.2d 486 (Ind. Ct. App. 2011) sheds light on what a “payoff” might mean in Indiana.  The case also reminds purchasers, their lenders and their title insurance companies to obtain releases of prior mortgages at the closing table. 

The story.  In 1998, Seeley obtained a home equity line of credit (HELOC).  In 1999, Seeley entered into an agreement to sell the subject real estate.  In advance of the closing, the title company discovered the HELOC mortgage and sent a “mortgage payoff request” to the HELOC lender.  The next day, the HELOC lender sent a “consumer loan payoff request” that listed the payoff amount, with a per diem.  The transaction closed, and the title company sent the HELOC lender a check for the full amount identified in the HELOC lender’s payoff request.  In the transmittal letter, the title company instructed the HELOC lender to “close account and release mortgage.  This property has been sold.”  The HELOC lender cashed the check but did not release its mortgage or close the line of credit.  The HELOC lender’s successor subsequently allowed Seeley to draw on the line of credit.  Seeley later defaulted, causing the HELOC lender to file suit to foreclose on the real estate, which a subsequent purchaser owned at the time.

“Payoff.”  In the trial court proceedings, the subsequent owner argued that the HELOC mortgage should be released.  The owner submitted an affidavit from the 1999 title agent stating, in part:

[t]he word “payoff” has a particular meaning in the real estate mortgage and title industry.  When a closing agent . . . receives a “payoff” figure, it understands that to be the amount the lender requires for a release of its mortgage, especially when the payoff figure contains no other instructions.

The evidence also showed that, after the closing, the HELOC lender never contacted the title company to advise that the payoff check or delivered documents were insufficient to obtain a release.

Obligation to release?  The subsequent owner argued that the payment, at closing, of the then-existing obligation, together with the circumstances surrounding it, obligated the HELOC lender to release its mortgage.  The HELOC lender contended that Seeley was required to provide a termination statement before it was bound to record a release. 

Rule 1 – not automatic.  The Court first noted that “unlike a term note, a [HELOC] is not automatically terminated when the balance is paid down to zero . . ..”  Such a rule would violate the very nature of the credit.  The Court in U.S. Bank concluded that the post-closing payment to the HELOC lender did not in and of itself terminate the HELOC. 

The real issue.  On the other hand, the Court said that the HELOC did not necessarily survive.  The test is whether the evidence establishes that the parties intended for the payment to terminate the HELOC.  The evidence in U.S. Bank showed just that - the “payoff” was the amount required to secure a release of the mortgage.  The title company remitted the requested amount, and the HELOC lender accepted it.  The icing on the cake was the title company’s letter, with the check, stating “please close account and release mortgage.  This property has been sold.”  Since the HELOC lender did nothing other than accept the cash, the payment obligated the HELOC lender to release its mortgage. 

Distinguishing Ping.  The HELOC lender relied on the 2008 Ping opinion, the subject of a prior blog post.  Under somewhat similar circumstances, the Ping Court did not require the release of the HELOC mortgage, even though there were payments that reduced the balance to zero.  The distinguishing factor between U.S. Bank and Ping was that the loan documents in Ping specifically required the mortgagor/owner to terminate the credit agreement before the mortgagee was required to release.  The mortgagor in Ping took no such action.  In U.S. Bank, the loan documents contained no such special requirements, but even so, unlike in Ping, the title company in U.S. Bank specifically requested a release of the mortgage. 

If you or your counsel are ever faced with a situation in which a line of credit mortgage was not released at a closing, despite a payoff, you should read the U.S. Bank and the Ping decisions for how Indiana courts might resolve the issue.  One way to prevent the problem in the first place is to require the lender to deliver an executed release at closing.  That way, the title company or the purchaser’s lender can control its recording, rather than relying upon the prior mortgagee/ lender to do so post-closing. 

Indiana District Court Examines “Material Adverse Change” Default Provision

The most common loan default is for non-payment.  But there are many other events that can trigger a default.  Indeed loan documents, including guaranties, typically contain a multitude of default-related provisions.  One provision that we often see, but rarely apply, looks something like this:

Insecurity.  Lender determines in good faith that a material adverse change has occurred in Guarantor’s financial condition from the conditions set forth in the most recent financial statement before the date of the Guaranty or that the prospect for payment or performance of the Debt is impaired for any reason.

Greenwood Place v. The Huntington National Bank, 2011 U.S. Dist. LEXIS 78736 (S.D. Ind. 2011) (rt click/save target as for .pdf) addresses a similar material adverse change (“MAC”) clause. 

Summary judgment.  In Greenwood Place, Southern District of Indiana Judge Tanya Walton Pratt issued a ruling on a motion for summary judgment filed by a lender against two borrowers based on the theory that there had been a “material adverse change in the financial condition of” the guarantor of the loans.  The opinion did not quote the entire clause, but it was clear that the subject loan agreement provided that “any material adverse change in the financial condition of” the guarantor constituted an event of default.  (Note that an alleged default occurred even though the loan payments were current.) 

The change.  Since the execution of the loan agreement, the guarantor’s cash had been almost completely depleted, his net worth had decreased by 60%, his equity in real estate had diminished by 80%, and he had unpaid judgments against him for several million dollars.  According to the Court, “to be sure, [guarantor] has experienced an adverse change in his financial condition.”  But, “whether this change has been material . . . is a more difficult question.”

The Court’s struggle.  The Court conceded that “at first blush, it would appear that this change has been material as that word is used in common parlance.”  Nevertheless, the Court noted that the loan documents did not define “any material adverse change.”  Evidence from six witnesses suggested different definitions.  Although the lender urged the Court to accept a “know it when you see it” interpretation, the Court was “uncomfortable” with applying such an approach at the summary judgment stage.  “Materiality,” noted the Court, is an “inherently amorphous concept.”  The guarantor still had a sizeable net worth that, based on certain assumptions, could be enough to absorb any liability stemming out of the underlying loans.  “This cushion creates questions as to whether the adverse change in [guarantor’s] financial condition is, in fact, material.” 

Ambiguous.  The Court denied the lender’s motion for summary judgment:

Given the “sliding scale” nature of materiality, coupled with the lack of a definition or objective standard found in the [loan agreement], the Court cannot help but find that the term is ambiguous because reasonable people could come to different conclusions about its meaning.  . . .  [T]herefore, “an examination of relevant extrinsic evidence is appropriate in order to ascertain the parties’ intent.”

Essentially, the Court held that the issue of materiality was a question of fact for trial. 

What we learned.  The Court’s analysis of the relevant financial conditions provides a road map for prosecutors (or defenders) of similar defaults.  The Court’s opinion does not question the fundamental validity or enforceability of MAC provisions.  The opinion does, however, raise the question of whether such a provision can form the basis for a pre-trial disposition of the case:  “when it comes to materiality, it’s all relative.”  The implication is that every case (financial condition) is different, and facts may need to be weighed.  On the other hand, Greenwood Place does not go so far as to proclaim that summary judgment should be denied in every case.  The opinion merely demonstrates how difficult summary judgment might be to achieve. 

Lender And IRS Battle Over Rental Income

I previously wrote about the priority of federal and state income tax liens on title to mortgaged real estate.  Generally, an Indiana mortgage lien on title to real estate will trump a tax lien, assuming the lender recorded the mortgage before the taxing authority recorded its lien.  The recent decision in Bloomfield State Bank v. United States of America, 644 F.3d 521 (7th Cir. 2011) involved a priority dispute over rental income arising out of the mortgaged real estate. 

Rents.  In Bloomfield, the borrower, who defaulted, granted the lender a mortgage on the borrower’s real estate plus “all rents . . . derived or owned by the Mortgagor directly or indirectly from the Real Estate or the Improvements” on it.  The IRS filed its 26 U.S.C. § 6321 lien for taxes against the subject real estate several years after the lender recorded its mortgage but before the filing of the foreclosure suit.  The receiver, during the pendency of the foreclosure case, decided to rent some of the real estate and collected about $80,000 in rents. 

Contentions.  The IRS claimed that its tax lien took priority over the mortgage lien on the rentals because they were received after the filing of the tax lien.  The argument of the IRS focused on 26 U.S.C. § 6323(h)(1), which gives a mortgage interest in rentals priority over a tax lien only if the property secured by the mortgage was “in existence” when the federal tax lien was filed.  The IRS asserted that the relevant property was the rentals – which did not exist at the time the federal tax lien attached.  The lender, on the other hand, claimed that the relevant property was the real estate - which did exist 

What existed and when?  The Court sorted through the “existence” issue:

The “property” that must be in existence for a lender’s lien to take priority over a federal tax lien is the property that, by virtue of a perfected security interest in it, is a source of value for repaying a loan in the event of a default; it is not the money the lender realizes by enforcing his security interest.

The Court reasoned that there essentially is no difference between lien-enforcement proceeds taken the form of sale income versus rental income.  “To say that a parcel of land is ‘sold’ rather than ‘rented’ just means that the owner sells the use of the land forever rather than for a limited period.”  In Bloomfield, the real estate that generated the subject rental income existed when the borrower granted the mortgage (and thus before the tax lien attached).  The rental income was proceeds of the such property, which preexisted the tax lien.

Not like A/R.  The result would have been different had accounts receivables been the lender’s collateral.  The Court noted that a security interest in accounts receivables does not exist and thus does not trump a subsequently-filed federal tax lien “until a buyer of goods or services from the grantor of the security interest becomes indebted to the grantor.”  If the lender in Bloomfield did not have a mortgage on its borrower’s real estate, but just a lien on rentals, then until the rentals were received “the property on which the bank had a lien would not have come into existence.”  Instead, the lender had a lien on the real estate.  The rentals provision in the mortgage “created a perfected security interest in rentals received at any time.”  Ind. Code § 32-21-4-2(c).  The Court said:

By virtue of the rental-income provision in the mortgage, the bank had a separate lien on the rents, but that is not the lien on which it is relying to trump the tax lien.  The lien on which it is relying is a lien on the real estate.  If an asset that secures a loan is sold and a receivable generated, the receivables become the security, substituting for the original asset.  The sort of receivable to which the statute denies priority over a federal tax lien is one that does not match an existing asset; a month’s rent is a receivable that matches the value of the property for that month.

The lender thus prevailed in its priority dispute with the IRS.  Bloomfield reminds us that, generally, Indiana is a “first in time is first in right” state.  More specifically, the opinion points out that in Indiana a mortgage attaches, not only to the land and improvements, but also to any proceeds from the sale or rental of the real estate. 

Payoff Statements: Handle With Care

In Indiana, mortgage lenders and their servicers should be very careful when issuing payoff statements.  Inaccurate statements could lead to the unintentional release of a mortgage.  Sutton Funding v. Jaworski, 2011 Ind. App. LEXIS 228 (Ind. Ct. App. 2011) illustrates this point and discusses the pertinent statute, Ind. Code § 32-29-6 “Mortgage Release by Title Insurance Companies.” 

The mess.  In 2004, the borrower in Sutton Funding received a mortgage loan from the lender in the amount of $325,000.00.  In 2007, the borrower sought to refinance the loan through a mortgage broker, which sought, and obtained, a payoff statement from the lender.  The payoff statement identified a payoff of $268,000.00 and articulated no other conditions.  The borrower closed on a $292,050.00 loan with a new lender.  $268,000.00 of the funds went to the original lender purportedly to satisfy the 2004 loan.  The closing called for the new lender to hold a first mortgage and for the original lender’s mortgage to be released.  The original lender accepted the money but failed to record a release of its mortgage.  Instead, the original lender and the borrower somehow executed loan modification documents but did not notify the subsequent lender, its broker or the title agent of this post-refinance activity. 

Legal action.  The borrower defaulted on the 2007 mortgage loan, and the new lender filed a foreclosure action.  In the suit, the original lender contended that the 2004 loan (and the mortgage) still existed because the debt had not been fully satisfied by the $268,000.00 payment.  The new lender relied upon I.C. § 32-29-6-13 and asserted that, by virtue of the payoff statement, Indiana law required the original lender to release the 2004 mortgage.

I.C. § 32-29-6.  This statute has only been around since 2002, and Sutton Funding appears to be the sole Indiana appellate court opinion that has construed it.  The statute is not limited to residential or consumer cases, although it only applies to mortgages securing loans in the original principal amount of $1,000,000 or less.  The guts of the statute relate to the who, what, when, where, why and how of “certificates of release.”  Sutton Funding focused on Section 13, which states: 

A creditor or mortgage servicer may not withhold the release of a mortgage if the written mortgage payoff statement misstates the amount of the payoff and the written payoff is relied upon in good faith by an independent closing agent without knowledge of the misstatement . . ..

Release mandated.  In Sutton Funding, there was no question that the payoff statement misstated the payoff amount.  The Court walked through the pertinent factual and legal points and concluded as a matter of law that both the broker and the title agent relied upon the payoff statement in good faith and without knowledge of the misstatement.  The result was an order compelling the release of the 2004 mortgage.  Due to the mistake in its payoff statement, the original lender’s claim to its collateral vanished.

All not lost.  As an aside, the original lender still could collect the full amount owed from the borrower.  Pursuant to language in Section 13, the debt itself will not be extinguished - only the mortgage.  An unsecured claim will survive.

Wrap-up.  Again, Sutton Funding and Indiana’s “Mortgage Release by Title Insurance Companies” statute do not apply to loans over $1,000,000.  That said, it’s conceivable that a Court could reach a similar result, based on common law principles, in a larger commercial case.  Sutton Funding is a powerful reminder that any written representations to a borrower with regard to a payoff should be accurate and should identify any applicable conditions to a release.

Attorney Fee Awards in Indiana

Parties that foreclose commercial mortgages, and collect debts based upon promissory notes or guaranties, almost always seek to recover their attorney’s fees.  Today’s post sets out why such a claim can be made and how the fees should be calculated.

American rule – contract needed.  Indiana follows the so-called “American Rule,” which provides that, in the absence of statutory authority or an agreement between the parties to the contrary, a prevailing party has no right to recover attorney’s fees from the opposition.  (Under the “English Rule,” the losing party pays the fees to the winning.)  Loparex v. MPI Release, 964 N.E.2d 806 (Ind. 2011).  Indiana’s foreclosure and commercial collection statutes generally do not authorize the recovery of attorney’s fees.  That’s why virtually every loan document I’ve seen contains an attorney fee clause. 

40% flat fee.  Corvee, Inc. v. Mark French, 934 N.E.2d 844 (Ind. Ct. App. 2011) teaches litigants about the amount of attorney’s fees a trial court may award to the plaintiff in a successful collection action in Indiana.  Corvee did not involve a promissory note but a similar written agreement between the parties related to the collection of reasonable attorney’s fees in a suit to recover a debt.  The provision in Corvee stated that the defendant was responsible “for reasonable interest, collection fees, attorney fees of the greater of a) forty percent (40%) or b) $300 of the outstanding balance, and/or court costs incurred in connection with any attempt to collect amounts I may owe.”  There was no dispute that the contract unambiguously required the defendant to pay the 40% amount.  The question was whether such provision was enforceable.

Liquidated damages.  The Court in Corvee concluded that the attorney fee provision in the contract was in the nature of a liquidated damages clause, which means that the contract provided for the forfeiture of a stated sum of money without proof of damages.  In Indiana, courts will not enforce a liquidated damages provision that operates as a penalty.  Liquidated damages clauses generally are valid only if the nature of the contract is such that damages resulting from a breach “would be uncertain and difficult to ascertain.”  The calculation of attorney’s fees incurred in litigation is not difficult to ascertain.  The Court said:  “it strikes us as unnecessary to transform a standard attorney fee provision in a contract into, effectively, a liquidated damages provision that may or may not have any correlation to actually incurred attorney’s fees.” 

The right way.  In Indiana, even with specific contract language, “an award of attorney’s fees must be reasonable.”  Citing to a case involving promissory notes, the Court stated that provisions “for the payment of attorney’s fees ‘should not extend beyond reimbursing the holder of the note for the necessary attorney’s fees reasonably and actually incurred in vindicating the holder’s collection rights by obtaining judgment on the note.’”  In Corvee, there was no evidence of the amount of attorney’s fees that the plaintiff actually incurred in attempting to collect the debt.  Thus the 40% recovery could have given rise to a windfall at the defendant’s expense.  “Collection actions should permit creditors to recover that to which they are rightfully entitled to make themselves whole, and no more.”  As such, Corvee held the 40% attorney fee provision to be unenforceable.

Assuming the existence of an attorney fee provision, lenders in loan enforcement actions may recover fees that are reasonable and actually incurred.  According to Corvee, flat-fee or percentage-based attorney fee clauses may be difficult to enforce in Indiana. 

(See alsoUnsettled:  Recovery of Attorney's Fees for In-House Counsel.)

Mortgagee Prevails In Claim For Indiana Tax Sale Surplus

What happens if a lender’s real estate collateral is sold at a tax sale, which nets a surplus (funds remaining over and above payment of the tax lien)?  Does the money go back to the owner, or can the lender/mortgagee recover it?  Beneficial Indiana v. Joy Properties, 942 N.E.2d 889 (Ind. Ct. App. 2011) helps answer these questions.

Course of events.  In 2003, lender made a mortgage loan to borrowers.  In 2008, following the failure by the borrowers to pay real estate taxes, the county held a tax sale that resulted in a $42,000 surplus.  No party redeemed within the one-year period, so the county issued a tax deed in November of 2009.  However, the tax sale purchaser did not immediately record it.  In December of 2009, lender filed a motion in the county trial court for the auditor to hold the surplus.  At the hearing on the motion, the lender established a default under the mortgage loan and losses of approximately $100,000.  Shortly after the hearing, borrowers, who did not participate in the hearing, deeded the real estate to a third party, which recorded the deed in January of 2010.  In February of 2010, lender filed a motion to compel the auditor to turn over the surplus, and then the the tax sale purchaser recorded its tax deed.

The problem.  Who should have received the $42,000 tax sale surplus - the lender or the third party (subsequent owner)?

Statute.  I.C. § 6-1.1-24-7 is the provision within Indiana’s tax sale statutory scheme that speaks to the surplus issue, and subsection (b) authorizes a claim by the:

 (1) owner of record of the real property at the time the tax deed is issued who is divested of ownership by the issuance of a tax deed; or
 (2) tax sale purchaser or purchaser’s assignee, upon redemption of the tract or item of real property.

Since there was no redemption, subsection (b)(2) did not apply.  Beneficial Indiana focused on subsection (b)(1), which seems to suggest that the borrowers would be entitled to the funds because they were the owners of record at the time the tax deed was issued.  Since they had conveyed their interests to a third party by the time the matter came before the trial court, the third party essentially stepped into their shoes and claimed subsection (b)(1) mandated the turnover of the surplus to it.

Statutory work around.  In Indiana, persons with “an interest in the real estate, including those who did not own the real estate at the time of the tax sale or who did not purchase the real estate at the tax sale, may assert a claim for a tax sale surplus directly with the trial court.”  The lender asserted that it was entitled to the surplus because its mortgage lien attached to the surplus.  Indiana law indeed provides that, even though the lender’s lien against the real estate was extinguished by the tax sale deed, its lien “attached to the tax sale surplus, and has priority over the interest conveyed to [the third party].”

More substantial interest.  The Court’s rationale rested upon the following test:  “which claimant has the more substantial interest in the real estate?”  The Court’s ruling in favor of the lender was, in my view, fair and sensible:

It is undisputed that [lender’s] mortgage was duly recorded on April 21, 2003.  It is further undisputed that the [borrowers] not only failed to pay their property taxes but also were in default on their mortgage, owing a balance that greatly exceeded the tax sale surplus held by the auditor.  Hence, [lender] had a substantial interest in the real estate prior to the issuance of the tax sale deed.  [Third party] acquired its interest in the real estate by a quitclaim deed executed by the [borrowers] after they had failed to make mortgage payments to [lender’s] for more than a year; and they had failed to redeem the real estate during the statutory one-year period following Allen County’s tax sale of real property due to the owners’ failure to pay real estate taxes.  Thus, at the time of the conveyance to [the third party] by the [borrowers], the interest conveyed was subject to the issuance of a tax deed to [the tax sale purchaser] and to [lender’s] recorded security interest.  In other words, the interest conveyed to [the third party] by the [borrowers] is significantly less substantial than and inferior to the interest of [lender].

Favorable to lenders.  As suggested here before on November 16, 2010 and most recently on March 19, 2012, delinquent real estate taxes and resulting tax sales can be a minefield for lenders in Indiana.  In Beneficial Indiana, the lender lost its loan collateral and incurred damages of about $100,000.00.  Luckily, the somewhat unique set of circumstances opened the door for the lender’s recovery of the surplus that mitigated its losses.

Priority Of HOA Liens In Indiana

Last week’s post dealt with a lien priority dispute between a mortgagee and a commercial property management association.  I thought that a natural follow-up post would be to clarify priorities between a more traditional residential homeowner’s association’s lien and a mortgage.  Secured lenders may from time to time foreclose upon its real estate loan collateral and discover that homeowner’s association liens have also been recorded on the subject property.  These issues are not exclusive to consumer foreclosures.  The can bubble up in commercial cases such as foreclosures upon failed residential subdivision developments. 

HOA statute.  Indiana has a separate and distinct statute devoted to homeowner’s association liens at Ind. Code § 32-28-14.  Homeowner’s associations (HOAs) may claim an interest in real estate that is the subject of a lender’s foreclosure case, and the HOA may even file its own case pursuant to I.C. § 32-28-14-8. 

Priority.  In determining priority, the critical question is - when did the HOA record its lien on a particular lot?  Pursuant to I.C. § 32-28-14-5, the priority of the lien of the HOA “is established on the date the notice of the lien is recorded . . ..”  See also, I.C. § 32-28-14-6.  Pursuant to Indiana’s recording statute, I.C. § 32-21-4-1(b), a lender’s mortgage will take priority according to the date of its filing.  Thus both liens take priority according to their filing/recording.  If the mortgage filing predated the filing of the HOA lien, then the mortgage will hold priority.  If, on the other hand, the HOA lien was recorded before the mortgage, then the HOA lien will have priority. 

Nothing unique.  HOA liens carry no special weight or any kind of super priority in Indiana.  Like most other liens, Indiana law determines the priority of an HOA lien based upon the date of its recording.

“Covenants and Restrictions” Maintenance/Assessment Lien Held To Be Subordinate To Mortgage Lien

PNC v. IRC, 2011 U.S. Dist. LEXIS 12389 (S.D. Ind. 2011) (.pdf)  involved a priority dispute between a junior mortgagee and a property management company, both of which possessed recorded liens on commercial real estate subject to a foreclosure case.  The issue was whether the junior mortgagee’s lien recorded in 2003 had priority over the management company’s lien recorded in 2009. 

The covenants and restrictions.  The subject real estate was an office park overseen by a property management company that I’ll call the “Association”.  The Association recorded certain covenants and restrictions against the real estate in 1991 pertaining to property maintenance and tenant behavior.  The covenants and restrictions provided that the Association could assess fees to cover administration of common areas and further provided that, if an owner failed to pay an assessment, the Association could file a lien against the owner’s parcel within the park.  The covenants and restrictions also stated that such lien “shall be subordinate only to the first mortgage, if any, which was on the Parcel at the time the assessments became due and payable.” 

The liens.  The borrower/mortgagor/owner in PNC failed to pay an assessment by the Association, resulting in the Association’s execution of a Notice of Association Lien that the Association recorded in 2009.  The competing lien holder, the United States Small Business Administration (“SBA”), in connection with a loan to the owner, recorded a junior/second mortgage on the subject property in 2003.  (There was no dispute that PNC, the first mortgagee, had the senior lien.)

The Association’s contention.  Even though its lien did not attach until 2009, the Association claimed that its lien should be senior to the SBA’s lien based upon the 1991 recordation of the covenants and restrictions.  The Association reasoned that “any party who might take an interest in the [property] after that date did so subject to the provisions of the [covenants and restrictions].”  The Association went on to claim that all parties with an interest in the case were on notice of the Association’s lien for any outstanding balance in a priority afforded to it by virtue of the 1991 recording.  The 2009 filing, according to the Association, simply was “a notice to the world of the balance existing under the [covenants and restrictions] at that moment in time.”  In short, 1991, not 2009, was the operative recording date.

The Court’s finding.  The Association and the SBA had competing summary judgment motions on the matter of priority.  Judge Lawrence of the United States District Court for the Southern District of Indiana noted that there was no Indiana case law directly on point.  He relied upon an Oregon decision, which essentially held, in the context of residential homeowner’s association fees, that there could be no debt and thus no lien until the Association exercised its power to make an assessment.  Applying the Oregon precedent to the facts of PNC, Judge Lawrence concluded:

Although the [covenants and restrictions] give [the Association] the authority to file a lien against a property owner who fails to pay his or her assessments, the [covenants and restrictions] themselves are not a lien.  No lien existed on the [property] until 2009.  Thus, [the Association’s] priority is based on the 2009 attachment.  This renders its lien junior to that of the SBA.

The Court granted summary judgment in favor of the SBA accordingly.  2009, not 1991, was the date of the recording that ultimately mattered.

First in time.  At its core, the Court basically applied Indiana’s “first to file” rule based upon Ind. Code § 32-21-4-1(b), which provides that mortgages take priority according to the date of their filing.  Since the filing (recording) of the SBA’s mortgage lien predated the filing (recording) of the Association’s assessment lien, the SBA prevailed.  The prior, 1991 recordation of the covenants and restrictions was of no moment.  Generally, therefore, a maintenance-related lien like that in PNC will be junior to a mortgage, assuming the mortgage gets recorded first. 

Lender’s Preservation Expenses Prime Mechanic’s Lien

Problems with construction mortgage loan defaults can be compounded by deterioration in the collateral when contractors stop working due to non-payment.  In certain cases, a lender might utilize a formal receivership to finish the project during the pendency of a foreclosure case.  In other cases, the expense of a receivership may not be warranted, or the lender may have no interest in funding the completion of the job.  Sometimes, only short-term repairs such as winterization are needed.  Does a lender’s claim for such direct advancements have priority over a mechanic’s lien claim?  Robert Neises Construction v. Kentland Bank, 2010 Ind. App. LEXIS 2449 (Ind. Ct. App. 2010) addressed that issue.


05/13/08       The borrower executed promissory note in favor of the bank in the amount of $193,000 and simultaneously delivered a mortgage against the subject real estate.  The $193,000 was to be used to construct a single-family residence.

04/2008        The borrower hired a contractor to construct the residence, and work began.

07/07/08      The bank recorded its mortgage.

07/14/08       The contractor filed a mechanic’s lien against the subject real estate in the amount of $22,369.

10/21/08        The contractor filed a complaint to foreclose its mechanic’s lien and named the bank.

12/11/08         The bank filed a counterclaim, crossclaim and third-party claim seeking to foreclose its mortgage on the subject real estate.

12/23/08         The bank filed an emergency motion to access the subject real estate and asserted that, pursuant to the terms of its mortgage, the bank had a right to preserve and protect the subject real estate.  The bank alleged that the contractor had stopped construction and had left the property in jeopardy of being destroyed or damaged due to weather.  Subsequently, the bank paid a separate contractor $20,188.91 to install a roof on the subject real estate and protect the structure from the elements.

Preservation expense super priority lien?  The question was whether the bank’s expenditures to protect the subject real estate from damage during the foreclosure case had priority over the mechanic’s lien.  There was no Indiana precedent or any specific statute providing the basis for the “preservation expenses” to be a super priority.  The Court in Neises Construction relied on the general principle that trial courts in Indiana mortgage foreclosure actions have “full discretion to fashion equitable remedies that are complete and fair to all parties involved.” 

Ruling.  Here is how the Court ruled:

It is undisputed, then, that [the bank] paid for the installation of a roof and other protective measures meant to preserve the integrity of the unfinished house, which benefited each of the lienholders.  There is no suggestion that the expenses were unreasonable or that the protective measures were otherwise ill-conceived.  Indeed, [the contractor] never objected to [the bank’s] emergency motion, so it cannot now complain.  Because [the bank], [the contractor] and the other lienholders were engaged in a common enterprise, and each benefited from the protective measures for which [the bank] bore the full expense, the trial court properly exercised its equitable powers to give [the bank] priority for preservation expenses over [the contractor] and the others in its distribution of the proceeds from the sheriff’s sale.

In short, since the bank’s “new money” helped everyone, the lien for the preservation expenses was senior. 

Parity scenario.  The Court noted that, in Indiana, a mortgage for construction of a house has the same priority as a mechanic’s lien where the mortgagee and the mechanic’s lien holder are engaged “in a common enterprise and neither of them is in a position to claim priority.”  Pursuant to Ward v. Yarnell, about which I have discussed previously, the bank’s and the contractor’s underlying liens were held in parity, but the bank’s preservation expense advancement maintained a separate and distinct senior status.  The contractor felt that even the new money to winterize the house should fall into the parity calculation, but the Court rejected the argument.  (Had Neises Construction been a commercial project, there would have been no dispute because parity wouldn’t enter the equation.  Pursuant to a separate statutory provision, the lender’s mortgage lien would be senior.  Since Neises Construction involved a residential project, Ward’s parity rule applied and thus created the opening for the contractor to at least fashion an argument.) 

In similar situations, and assuming a mortgage provision supports it, lenders involved in failed construction projects in Indiana can be assured that preservation expenses they advance will hold super priority status, generally superior to most all other liens except for delinquent real estate taxes.  Neises Construction also illustrates that a formal receivership isn’t always necessary to preserve and protect the property during foreclosure.

Will Mysterious Post-Sale Redemption Statute Be Clarified ... And What About The Treatment Of MERS?

I've learned that, on April 10th, the Indiana Supreme Court granted transfer in the CitiMortgage v. Barabas case about which I've written on four prior occasions, most recently on March 29th:  Indiana Legislation, 2012:  Part 2 of 3 - Obscure Redemption Language Remains.  In Indiana, a decision to grant transfer automatically vacates opinions of the Court of Appeals or, in other words, negates the prior case law.  So, perhaps later this year we'll hear from Indiana's highest court on some important foreclosure-related topics, including post-sale redemption rights and the treatment of MERS.  Interestingly, the opinion will be rendered after the 2012 legislation that amended the operative statute, Ind. Code Section 32-29-8.  It's unclear to me whether or to what extent the Court will take into account or otherwise touch upon the amended statute.  I'll be on the lookout for the Court's decision and will post about it accordingly.    

NOTE:  On 10-4-12, the Supreme Court reversed the trial court.

In Indiana, Failure To Comply With HUD Servicing Regulations Can Be A Defense To A Foreclosure Action

While not directly applicable to commercial cases, Lacy-McKinney v. Taylor, Bean & Whitaker Mortgage, 937 N.E.2d 853 (Ind. Ct. App. 2010) is worth mentioning here. If you are involved in residential mortgage foreclosures in Indiana, you should be aware of the Lacy-McKinney decision. The case addressed the question of whether a lender/mortgagee’s lack of compliance with federal mortgage servicing responsibilities may be raised as an affirmative defense to the foreclosure of an FHA-insured mortgage.

HUD language. The Lacy-McKinney note and mortgage, which were in default for non-payment, referenced the applicability of HUD regulations to the loan. The terms of the loan documents clearly spelled out that regulations limited the lender’s right to accelerate and foreclose. For example, the borrower claimed that the lender did not satisfy a HUD regulation requiring a face-to-face meeting before the filing of a complaint for foreclosure.

The issue. The main issue in Lacy-McKinney was: are the HUD regulations binding conditions precedent that must be complied with before a lender has the right to foreclose on a HUD-insured mortgage? (Please note that the quarrel over the condition precedent did not affect the validity of the mortgage, but only whether the lender had a right at the time to foreclose on the mortgage.)

First impression. The issue was one of “first impression” in Indiana – meaning that the legal question was entirely novel and could not be governed by any existing Indiana precedent. The opinion thoroughly outlined the background of HUD-insured mortgages and some of the applicable regulations. (Read the opinion for more detail.) The case also discussed other states’ positions on the issue.

Defense recognized. The Court concluded that an affirmative defense should be recognized for non-compliance with HUD regulations under the circumstances:

The above precedents, the language of the HUD regulations, and the public policy of HUD persuade us that the HUD servicing responsibilities at issue in this case are binding conditions precedent that must be complied with before a [lender] has the right to foreclose on a HUD property. As such [borrower] can properly raise as an affirmative defense that [lender] failed to comply with the HUD servicing regulations prior to commencing this foreclosure action.

Summary judgment reversed. The Court went on to hold that the trial court’s summary judgment in favor of the lender should be reversed. “The trial court erred in granting summary judgment in favor of [lender] on its action to foreclose on [borrower’s] HUD-insured mortgage without first determining that [lender] had complied with Subpart C – the conditions precedent to foreclosure.” The Court therefore remanded the case to the trial court for further proceedings – likely a dismissal of the case. Ultimately, the lender in Lacy-McKinney may win the foreclosure war, but the borrower won this battle.

Those who deal in this area, whether they be lenders, borrower or counsel, should be familiar with this case. The loan document provisions and regulations appear to be consistent with 2009 Indiana state and local law developments requiring pre-suit settlement conferences, etc. about which I discussed on March 15, 2009 and June 19, 2009. Depending upon the contents of the loan documents, HUD-related “i’s” need to be dotted and “t’s” need to be crossed before suit can even be filed.

Court Clarifies Its Reasoning In CitiMortgage/Redemption Case - Did It Help?

On August 2nd, I discussed how the Indiana Court of Appeals precluded MERS and its assignee from asserting an interest in the mortgaged property due to timeliness issues. Here's my post: Senior Mortgagee Time Barred. The outcome of the decision rested in part on Ind. Code 32-29-8-3 and a mysterious (to me) post-sheriff's sale right of redemption.

Correction. On rehearing, the Court, on October 20th, issued an opinion in the case that, in part, cleared up the statutory redemption issue:

We agree that the correct interpretation of the statute is that the one-year redemption period begins after the sale of the property [the sheriff's sale], not after Citi first acquired an interest in the property.

Nevertheless, the decision against the senior mortgagee remained the same. As noted in my August 2nd post, the concept of redemption as it might apply to the CitiMortgage case was admittedly confusing and surprising to me. And I'm not sure the opinion on rehearing helped too much, other than to clarify the date upon which the clock should start ticking.

Application. I conducted some limited research for case law on this statutory section and found very little decisional law interpreting it. All I can conclude is that there may be a limited, extraordinary post-sheriff's sale right of redemption for assignees of mortgages whose assignments were not recorded before the filing of the foreclosure complaint. The redemption right clearly does not apply to borrowers or mortgagors.

Know it's there. I welcome emails or comments about CitiMortgage or Ind. Code 32-29-8-3. The point for secured lenders - specifically, assignees of mortgages - is that an unknown foreclosure sale may not be immediately fatal to your mortgage interest if the assignment wasn't recorded. On the flip side, sheriff's sale purchasers - thinking they hold title free and clear of all liens - could under narrow circumstances be in for a surprise. My head starts to spin when I consider all the logistics that could come in to play. Lesson: always buy an owner's policy of title insurance....

NOTE: See my March 29, 2012 post re: new legislation amending Section 3 and my 4-21-12 post noting that transfer has been granted by the Supreme Court.  On 10-4-12, the Supreme Court reversed the trial court. 


Indiana Supreme Court Speaks To The Doctrine Of Merger And The Remedy Of Strict Foreclosure

The doctrine of merger and the remedy of strict foreclosure have been hot topics in Indiana’s appellate courts over the last couple of years. The development of the law has centered upon two cases: Deutche Bank v. Mark Dill Plumbing and Citizens State Bank of New Castle v. Countrywide Home Loans, Inc. In 2009, I posted four articles about Deutche Bank: April 17, April 24, May 4 and July 20. In 2010, I wrote about Citizens State Bank. Earlier this year, the Indiana Supreme Court vacated the Court of Appeals’ opinion in Citizens State Bank and issued its own decision, seemingly closing the books for the foreseeable future on this area of the law (.pdf) . The subject – big picture – relates to the impact of a foreclosing mortgagee’s failure to include a junior lien holder in a foreclosure case.

At issue. I outlined the key facts of the Citizens State Bank in my September 20, 2010 post. The Supreme Court distilled the dispute to its essence:

A mortgage holder foreclosed its mortgage, took title to the subject property at a sheriff’s sale, and then sold the property to a third party. The foreclosing mortgagee subsequently discovered it had inadvertently failed to name a junior lienholder in the foreclosure action. We granted transfer to shed light on the status of the original first mortgage in this context.

Merger. On pages 3 through 5 of the opinion, the Court provides an excellent discussion of Indiana’s doctrine of merger, including an explanation of the “equity of redemption.” The idea of “merger,” as noted by the Court, typically means that the mortgagee, in a foreclosure, acquires both the lien and legal title to the real estate so as to “merge” those two interests. That is, “the mortgage merges with the legal title, and the lien is thereby extinguished.”

Strict foreclosure. As suggested in the line of Deutche Bank’s cases, in my opinion the remedy of strict foreclosure (forfeiture, really) technically doesn’t exist in Indiana, even though lawyers and lenders frequently use that terminology. Here’s what the Indiana Supreme Court said about the remedy as it applied in Citizens State Bank:

But there is nothing particularly sacrosanct about a strict foreclosure action. That is to say, simply alleging that strict foreclosure would be a proper remedy does not make it so, nor does such allegation resolve the question of merger. In the end strict foreclosure as used in this case is merely a mechanism to place before the court the question of whether the doctrine of merger should be enforced.

Presumption. Regarding the enforceability of the doctrine of merger, the Court stated:

As indicated earlier in this opinion our case authority declares, “[w]hether the conveyance of the fee to the mortgagee results in a merger of the mortgage and the fee depends primarily upon the intention of the parties, particularly that of the mortgagee.” This is not, in our view, an “anti-merger” rule. Instead, we view it simply as an exception to the [merger] rule, providing a starting point in determining whether merger occurred in the first instance.

The “presumption” is that a mortgagee intends to do that which is most advantageous to itself. But the presumption is not conclusive and may be rebutted by evidence showing “that a merger had been expressly agreed to, or that the mortgagee’s conduct and action were such as could fairly be ascribed only to an intention to merge.” In basic terms, the question is whether the parties desired to extinguish the mortgage lien.

Holding. The Court ultimately found that the evidence in Citizens State Bank rebutted the presumption that the mortgagee wanted the two estates (mortgage and title) to remain separate. The Court focused on the limited warranty deed that transferred the property to the third party, FNMA. “Countrywide’s intent was manifest: conveyance of title in fee simple, free of all encumbrances.” The Court reasoned that “simply because in retrospect it might not have been in Countrywide’s ‘best interest’ to extinguish its mortgage lien when it conveyed the property to FNMA cannot change Countrywide’s intent after the fact.” The Court held that the third party, FNMA, acquired the property subject to the valid judgment lien. (This result may have been prevented had the mortgagee and FNMA used the “anti-merger” language typically used in deeds-in-lieu of foreclosure.)

Not always. The Court noted that there may be circumstances under which the equitable remedy of strict foreclosure (actually quiet title relief, in my view) still may be appropriate. Certainly a mortgagee’s intent is of primary importance. An example of this would be a case in which a junior lien was not joined in the foreclosure action due to an indexing error that prevented the lien from appearing in court records. Under the facts of Citizens State Bank, however, the record was clear that the junior lien on the real estate was properly recorded and indexed, and the lien simply was overlooked due to the senior mortgagee’s mistake and/or inadvertence.

Citizens State Bank is another one of those decisions that drives home the point that an owner’s policy of title insurance is a wise investment for foreclosing lenders.

NOTE: Legislation in 2012 impacted these issues.

Indiana’s Take On MERS, Part II: The “Straw Man”

This follows up last week’s post regarding CitiMortgage.  In an effort to defeat ReCasa’s Ind. Code § 32-29-8-3 argument, Citi contended that an analysis of Section 3 was not necessary for the reason that the mortgagee of record was MERS.  Citi claimed that MERS, not Irwin, should’ve been given notice of ReCasa’s foreclosure suit.  See, I.C. § 32-29-8-1.  The Court didn’t bite.

Notice language.  Remember that MERS/Citi claimed that they did not receive proper notice of the foreclosure suit.  But, their own mortgage had the following language with respect to notice:

Any notice to Lender shall be given by first class mail to Lender’s address stated herein or any address Lender designates by notice to Borrower.  Any notice provided for in this Security Instrument shall be deemed to have been given to Borrower or Lender when given as provided in this paragraph.

The mortgage defined the lender as Irwin and provided Irwin’s address.  The mortgage also provided that Barabas owed Lender (thus Irwin, not MERS) money. 

Mortgage language.  The mortgage stated that MERS served “solely as nominee” for Irwin.  It appears that much of the confusion in the litigation arose out of the ambiguities in the mortgage.  Read the language for yourself: 

This Security Instrument is given to Mortgage Electronic Registration Systems, Inc. (“MERS”), (solely as nominee for Lender, as hereinafter defined, and Lender’s successors and assigns), as mortgagee. 

Irwin the mortgagee.  To determine whether MERS or Irwin was the mortgagee, the Court focused heavily on a 2009 decision by the Kansas Supreme Court Landmark v. Kesler, 216 P.3d 158 (Kan. 2009).  “The Kansas Supreme Court found that in this case, MERS was little more than a ‘straw man’ for [the lender].”  For more in-depth analysis, read CitiMortgage.  The Indiana Court of Appeals affirmed the trial court’s ruling, which declined to set aside ReCasa’s default judgment that placed ReCasa’s mortgage in first position.  The Court held:

When Irwin Mortgage filed a petition and disclaimed its interest in the foreclosure, MERS as mere nominee and holder of nothing more than bare legal title to the mortgage, did not have an enforceable right under the mortgage separate from the interest held by Irwin Mortgage.

Who to sue?  As a litigator, the role of MERS has always struck me as odd.  In practice, MERS may be a nice vehicle for commerce involving mortgage loans.  But, once the loans go into default and the mortgages must be judicially enforced, problems with interpreting the documents’ language have bubbled to the surface.  If, in the future, you or your foreclosure counsel struggle with whether to name MERS as a defendant, perhaps to be safe you should name both the identified lender and MERS, even though the CitiMortgage opinion suggests that MERS need not be named.  (CitiMortgage also demonstrates the need for a title commitment and an owner’s policy.  The commitment should help lenders decide whether to name MERS.) 

I understand Citi has filed a petition to transfer the case to the Indiana Supreme Court, so our State may not be done with creating law about MERS (transfer granted 4-10-12).  For more insight into how MERS views some of these issues, please see these links to its website:

• MERS as original mortgagee
• MERS foreclosures/bankruptcy
• Judicial decisions
• Case law outlines

NOTE:  On 10-4-12, the Indiana Supreme Court reversed the trial court. 

For The First Time, Indiana Court Tackles MERS: Part I, Senior Mortgagee Time Barred

The confusing role of Mortgage Electronic Registration Systems, Inc. (“MERS”) in the holding of mortgages has been a hot topic across the country for the last few years.  The May 17, 2011 opinion by the Indiana Court of Appeals in CitiMortgage v. Barabas, 2011 Ind. App. LEXIS 892 (.pdf) is the first instance in which Indiana has spoken definitively about MERS – “little more than a ‘straw man’ for lenders,” according to the Court.  Here, in Part I about CitiMortgage, we look at the Indiana statute that dictates the parties, including assignees, to be named in a foreclosure suit. 

The history.  CitiMortgage arose out of a foreclosure case, which made its way to the Court of Appeals by virtue of the trial court’s refusal to set aside a default judgment that terminated the senior mortgage on the property.  The 2005 senior mortgage was given to MERS, “as nominee” of Irwin, the lender.  In June, 2008, junior mortgagee ReCasa initiated a foreclosure action and named only Irwin (not MERS), the purported senior mortgagee, as a defendant.  Irwin promptly filed a disclaimer of interest and was dismissed from the case.  The trial court entered a default judgment for ReCasa in September, 2008.  ReCasa acquired the property at the January, 2009 sheriff’s sale and sold the property to third-party Sanders two months later.

The rub.  A month after the March, 2009 Sanders sale, Citi recorded an assignment of the MERS/Irwin mortgage, even though the evidence showed that Citi acquired an interest in the mortgage as early as July, 2008.  In October, 2009, Citi moved to intervene in the ReCasa foreclosure action, requested relief from the default judgment and sought to set aside the sheriff’s sale.  Citi asserted that, as assignee of MERS, it held a first-priority mortgage on the property.  The fundamental question was whether ReCasa’s failure to name MERS as a defendant rendered ReCasa’s foreclosure judgment ineffective as to Citi.  (See, 12-21-06 post.)

The critical statutes.  Ind. Code § 32-29-8 “Parties to Foreclosure Suit; Redemption” controlled the Court’s analysis.  Here are all three sections of the statute:

Mortgagee or assignee; purchaser at judicial sale
 Sec. 1. If a suit is brought to foreclose a mortgage, the mortgagee or an assignee shown on the record to hold an interest in the mortgage shall be named as a defendant.

Failure to record or join foreclosure action
 Sec. 2. A person who fails to:
  (1) have an assignment of the mortgage made to the person properly placed on the mortgage record; or
  (2) be made a party to the foreclosure action;
is bound by the court's judgment or decree as if the person were a party to the suit.

Good faith purchaser at judicial sale
 Sec. 3. A person who purchases a mortgaged premises or any part of a mortgaged premises under the court's judgment or decree at a judicial sale or who claims title to the mortgaged premises under the judgment or decree, buying without actual notice of an assignment that is not of record or of the transfer of a note, the holder of which is not a party to the action, holds the premises free and discharged of the lien. However, any assignee or transferee may redeem the premises, like any other creditor, during the period of one (1) year after the sale.

The ruling, and Section 3.  CitiMortgage relied heavily on Section 3.  The Court denied the relief requested by Citi and reasoned that:

over a year after ReCasa first foreclosed on the Property [filed suit] and nearly six months after the Property was sold and recorded, Citi sought to assert its interest in the first mortgage.  Based on this information, it is clear that the trial court did not abuse its discretion when it found that I.C. § 32-29-8-3 precluded Citi’s claim because it failed to intervene until more than a year after it first acquired interest in the Property. 

Citi’s intervention, in October, 2009, was indeed over a year after Citi first acquired an interest in the property –July, 2008 or earlier.  But interestingly those facts don’t track the language in Section 3, which speaks to redeeming – not intervening – within a year of the sheriff’s sale – not the assignment date. 

The redemption right.  Admittedly, I don’t fully grasp the Court’s suggestion that Citi somehow had a right of redemption but failed to exercise it within a year.  The CitiMortgage sheriff’s sale was in January of 2009, and Citi moved to intervene nine months later.  Perhaps I’m misinterpreting the Court’s rationale.  I further confess that I’m having trouble reconciling the last sentence in Section 3, particularly the “like any other creditor” phrase, with well-settled Indiana law providing that a sheriff’s sale terminates the right of redemption.  (See, 5-15-08 post.)  This assignee-related/redemption wrinkle will have to be a topic for another day…. 

The Section 2 impact.  It appears to me that Section 2, not Section 3, more clearly supports the Court’s conclusion because Citi failed to timely record the assignment of mortgage and intervene sooner.  There was evidence that Citi knew about ReCasa’s foreclosure action long before it intervened.  Reading between the lines, perhaps CitMortgage’s ultimate lesson is that assignees should record their assignments immediately and then promptly intervene in a known foreclosure action.  (See, 5-28-09 and 10-14-09 posts.)

In the second part of the CitiMortgage opinion, which I’ll discuss next week, the Court specifically hashes out the enigma that is MERS and rejects Citi’s argument around Section 3. 

Note:  The Court, on rehearing, clarified its reasoning related to Section 3.  Here's my 11-1-11 follow-up post.  Furthermore, on 4-10-12, the Supreme Court granted transfer, and on 10-4-12 reversed the trial court.

To Be Enforceable, An Indiana Mortgage Must Adequately Describe The Debt It Purports To Secure

It’s pretty rare to read a case in which a court renders a commercial mortgage invalid.  But that’s what happened in SPCP v. Dolson, 2010 Ind. App. LEXIS 1852 (Ind. Ct. App. 2010) (.pdf).  Secured lenders beware:  if your mortgage contains an inaccurate and materially misleading description of the debt, you will lose your foreclosure remedy.

Purported mortgagor was a surety.  In SPCP, the alleged mortgagor, Holland, owned real estate that she leased to Dolson, a company that operated a pub.  The lease provided that Holland and Dolson could participate in a mortgage loan related to the real estate.  In fact, a lender, SPCP, made a $700,000 loan to Dolson.  The Dolls (officers in Dolson) and Thompson (Mrs. Doll’s father) guaranteed the loan.  Holland co-signed a mortgage with Dolson in favor of SPCP.  Holland did not, however, review or sign the underlying promissory note.   

Mortgages 101.  The SPCP opinion outlined the basic statutory requirements for a valid mortgage in Indiana (Ind. Code § 32-29-1-5).  A mortgage must recite both (1) the date for repayment and (2) one or more of:  (a) the sum for which it is granted; (b) the notes or evidences of debt; or (c) a description of the debt sought to be secured.  Mortgages must also be dated and signed, sealed and acknowledged by the grantor. 

Debt description.  With regard to the accuracy of the debt description, Indiana cases say:

literal accuracy in describing the debt secured by the mortgage is not required, but the description of the debt must be correct, so far as it goes, and full enough to direct attention to the sources of correct information in regard to it, and be such as not to mislead or deceive, as to the nature or amount of it, by the language used.  . . .  A reasonably certain description of the debt is required so as to preclude the parties from substituting debts other than those described for the mere purpose of defrauding creditors.

SPCP refined this summary of the law into a two-part test:  (1) whether the debt description was inaccurate and (2) whether the inaccuracy was sufficiently material to mislead or deceive the grantor/mortgagor as to the nature or amount of the debt. 

The inaccuracy.  The mortgage signed in SPCP secured debt “incurred under the terms of ‘a’ Promissory Note dated December 27, 2001 executed by Dolson, the Dolls and Thompson and maturing December 27, 2021.”  This accurately described the date of execution of the subject note and the maturity date but inaccurately described the identity of the note’s makers.  Thompson did not execute the note.  He signed a guaranty.  The Court held that the mortgage’s description of the debt was inaccurate. 

Materially misleading.  Moreover, the Court, in affirming the trial court’s summary judgment for Holland, concluded that the inaccuracy was sufficiently material so as to mislead Holland.  The Court articulated three reasons for its decision, all of which centered on the role of Thompson:

     1. Release.  After Dolson defaulted on the loan, SPCP settled with Thompson for $550,000 and released him from liability.  Holland, in agreeing to the mortgage, acted only as a surety pledging collateral to secure the loan of Dolson.  If Thompson had been liable on the note as a primary obligor (a maker), and not a guarantor, then any release of Thompson would, under Indiana law, have released Holland and her real estate.  Because Thompson was only a guarantor and thus a co-surety with Holland, the release of Thompson did not have that effect. 

     2. Subrogation.  Thompson’s status as guarantor, instead of co-maker of the note, changed Holland’s recourse against Thompson.  Under Indiana law, sureties have the right to complete reimbursement and subrogation from makers.  As only a co-surety, Thompson, at most, was exposed to Holland for Holland’s pro-rata contribution to the debt.  Thus the loan structure increased Holland’s risk of loss.  (I discussed suretyship law on 5-23-07.)

     3. Detrimental reliance.  Holland testified it was her understanding that her real estate would be subject to foreclosure only if the Dolls and Thompson failed to pay the debt.  Holland therefore relied to her detriment on the mortgage’s inaccurate description of Thompson as a co-maker.  Holland claimed that she would not have signed the mortgage had she known that Thompson was only a guarantor. 

Over the last few years, I have seen a handful of cases like SPCP in which the mortgagor was not the borrower but merely a pledgor of real estate.  In those cases, unlike SPCP, the language in the mortgage clearly connected the mortgage with the note.  The loan documents in SPCP lacked that clarity, and the alleged mortgagor was able to seize on the inaccuracy to save her commercial real estate from foreclosure.

Alleged Oral Release Of Mortgage Rejected

In Yoost v. Zalcberg, 2010 Ind. App. LEXIS 632 (Ind. Ct. App. 2010) (.pdf) , the Indiana Court of Appeals addressed the issue of whether an alleged oral release of a mortgage was enforceable.  At issue was Indiana’s Statute of Frauds, a subject I covered on April 16, 2010.  There are a handful of exceptions to the Statute of Frauds, and the Court in Yoost discussed one of them – the doctrine of promissory estoppel.  As explained, oral releases from loan documents are very difficult to uphold.   

Backdrop.  In Yoost, the defendant (Yoost) was the plaintiff’s (Zalcberg’s) paid personal assistant.  Zalcberg agreed to lend money to Yoost to buy a house, and the parties executed a note and a mortgage.  Yoost defaulted but claimed Zalcberg had orally agreed to release Yoost from the mortgage.  Yoost continued to work for Zalcberg for another year in reliance on the alleged oral release. 

Statute of Frauds.  The first step in the Court’s analysis was to examine Indiana’s Statute of Frauds, specifically Ind. Code § 32-21-1-1(b):

A person may not bring any of the following actions unless the promise, contract, or agreement on which the action is based, or a memorandum or note describing the promises, contract, or agreement on which the action is based, is in writing and signed by the party against whom the action is brought or by the party’s authorized agent:

(4)  An action involving any contract for the sale of land.

Promissory estoppel exception.  Yoost conceded that the alleged promise (release) was in contravention of the Statute of Frauds.  The question was whether the doctrine of promissory estoppel removed the alleged release from the writing requirement.  A party seeking to preclude application of the Statute of Frauds based on this doctrine must establish:

1. a promise by the promisor;
2. made with the expectation that the promisee will rely on the promise;
3. that induces reasonable reliance by the promisee;
4. of a definite and substantial nature; and
5. that injustice can be avoided only by enforcement of the promise.

Yoost cited to an Indiana Supreme Court opinion expanding on this concept:

in order to establish an estoppel to remove the case from the operation of the Statute of Frauds, the party must show that the other party’s refusal to carry out the terms of the agreement has resulted not merely in a denial of the rights which the agreement was intended to confer, but the infliction of an unjust and unconscionable injury and loss.

Thus, to prevail on a claim of promissory estoppel, a party must establish that there is a genuine issue of material fact that his reliance injury is not only (1) independent from the benefit of the bargain and the resulting incidental expenses and inconvenience, but also (2) so substantial as to constitute an unjust and unconscionable injury.

No independent reliance injury.  Yoost asserted that he suffered the required “independent reliance injury” by continuing to work for over a year at an extremely low rate of pay in reliance on the alleged oral release of mortgage.  But the Court found “nothing about [Zalcberg’s] alleged oral promise substantially changed either party’s behavior.”  The Court saw no inconvenience to Yoost, much less any unjust and unconscionable injury. 

Borrowers in Indiana will have a difficult time overcoming the Statute of Frauds, as well as the Lender Liability Act about which I posted on October 29, 2010, December 31, 2008, and July 11, 2008Yoost is more good precedent for creditors.  Courts generally focus on the written terms of the agreement and do not unravel loan documents absent written, signed representations to the contrary. 

Indiana Court Discusses Whether A Lender Was A “Bona Fide Mortgagee”

Imagine making a mortgage loan and later having a court determine that the mortgage is invalid.  What you thought was a secured debt suddenly becomes unsecured.  That’s what happened in Thomas v. Thomas 2010 Ind. App. LEXIS 389 (Ind. Ct. App. 2010)

The story.  The Thomas case involved some pretty bizarre facts.  The case dealt with Lender, Father (who owned real estate) and Father’s two sons.  Father purchased the property in 1965 and lived there continuously and throughout the litigation.  For estate planning purposes, he deeded the property in 1977 to Son 1, with the oral understanding that Son 1 would deed the property back at any time upon request.  In 1995, Son 1 deeded the property to Son 2, and Son 2 knew that he must convey the property back to Father upon request.  In early 2001, Father asked Son 2 to deed the property back, but Son 2 refused.  In response, Father recorded a $200,000 mechanic’s lien notice on the property and also filed a quiet title lawsuit.  In late 2001, Son 2 obtained a $118,000 mortgage loan from Lender based, in part, on a forged and technically-flawed mechanic’s lien release.  In 2002, Father filed a foreclosure lawsuit with respect to the mechanic’s lien and named Lender as a defendant.  In 2003, Son 2 filed bankruptcy and ended up conveying the property back to Father.  In 2007, Lender had the mechanic’s lien rendered invalid in the mechanic’s lien foreclosure suit.  The mess thus boiled down to a battle, in the foreclosure case, between Father and Lender as to whether the mortgage was invalid. 

Bona fide mortgagee rule.  The Court’s opinion in Thomas surrounded whether Lender was or was not a “bona fide mortgagee.”  While I’ve previously discussed here (May 8, 2010 and October 4, 2009) the “bona fide purchaser” defense, I’ve not posted about the “bona fide mortgagee” doctrine.  The Court noted that the Indiana bona fide purchaser doctrine “applies with equal force to mortgagees.”  Although the Court did not articulate the test for how a lender/mortgagee would qualify as a bona fide mortgagee, application of the bona fide purchaser test suggests that the lender would have to acquire a mortgage in good faith, for valuable consideration, and without notice of the outstanding rights of others.  It follows that the defense is premised on the theory that every reasonable effort should be made to protect a lender who acquired a mortgage for valuable consideration without notice of a legal defect.

Duty to inspect?  Since Lender clearly acquired the mortgage for valuable consideration, the issues in Thomas were whether Lender (1) acted with good faith and (2) without notice of Father’s rights.  To my surprise, the Court sided with Father on both points and rendered Lender’s mortgage invalid.  The Court first focused on Father’s possessory rights.  In Indiana, generally speaking, “one who fails to examine land which he is about to purchase, and to inquire as to the rights of one in possession, is not acting in good faith and will not be treated as a bona fide purchaser.”  Furthermore, “possession of land puts the world on notice that the possessor may have a claim of ownership and right to possession.”  The Court utilized all these various legal principles to arrive at the following conclusion:

Quite simply, it is undisputed that [Father] was in possession of the property in question and that [Lender] nonetheless did nothing to ascertain his rights to it.  It is apparent that even a cursory investigation would have quickly uncovered both [Son 2’s] fraud and [Father’s] claims on the home.  Under the circumstances, [Lender] cannot have been a bona fide mortgagee, and we therefore affirm the trial court’s judgment in this regard.

Frankly, I’m still trying to wrap my head around what this holding means to lenders.  Remember, Son 2 had the deed and thus title to the property.  Beyond that, do lenders actually need to verify whether who is in possession of the property and determine his, her or its rights to title?  Hmmm . . ..  I welcome the posting of comments or emails about this matter.

Bogus lien release.  The Court seemed to back off of the notion that lenders must physically inspect their real estate collateral - - saying that, “even in the absence of a duty to inspect,” the “irregularities on the face of the forged release of mechanic’s lien” should have put Lender, as a reasonably prudent person, on inquiry notice that something was amiss.  Basically, the Court felt that anyone reviewing the mechanic’s lien release should have questioned the authenticity of it.  Lender “clearly had the means to discover that the lien the forged instrument purported to release did not exist . . . we believe that a reasonably prudent lender would have taken the simple steps necessary to verify that a superior $200,000 mechanic’s lien had indeed been released.”  All told, the Court held that Lender could not have been a bona fide mortgagee due to “its failure to investigate [Father’s] interest in the home.” 

Much more could be said about Thomas, particularly regarding the potentially scary proposition that under certain circumstances lenders may have some burden to physically inspect real estate before making a loan in order to verify the possessor is also the mortgagor/owner.  But allow me to conclude with this one piece of simple advice:  always get title insurance when you’re initially making a mortgage loan or later foreclosing on the mortgage.  Title work, including loan policies and owner’s policies, provide a critically-important level of protection for lenders.  Assuming the Lender/Son 2 closing was insured, presumably the title company and not the Lender ultimately will bear the loss in the Thomas case.   

Judgment Lien And Mortgage Lien Governed By Different Statutes Of Limitations

In Welch v. Heavelin, 2009 Ind. App. LEXIS 2518 (Ind. Ct. App. 2009) (.pdf) , mortgagor tried to defeat mortgagees’ foreclosure action by asserting the ten-year judgment lien statute of limitations defense.  The Indiana Court of Appeals rejected the mortgagor’s position and explained that the mortgagees sought to enforce a mortgage lien not a judgment lien.   

Creation of lien.  Husband and Wife were divorced in 1993.  In the divorce decree, the court awarded Husband certain real estate but required Husband to pay Wife money.  Husband’s payment obligation was secured by a mortgage on the real estate.  Husband/mortgagor did not pay the monetary obligation called for under the divorce decree, but Wife never enforced the mortgage.  She passed away in 2003, and her heirs were assigned the mortgage and therefore became the mortgagees.  They filed a foreclosure action in 2008, fifteen years after the creation of the mortgage. 

Mortgagor’s defense.  Husband/mortgagor, based upon Ind. Code § 34-55-9-2, claimed that the foreclosure action was time-barred because the lien expired after ten years, or in 2003.  The Court noted, however, that I.C. § 34-55-9-2 applies only to judgment liens or, more specifically, lien created by judgments for the recovery of money.  I wrote about this ten-year judgment lien statute on November 13, 2008. The mortgagees did not sue to foreclose a judgment lien.  They sued to foreclose the mortgage lien.   The statute upon which Husband/mortgagor relied therefore did not apply. 

Mortgage lien statute of limitations.  The Court concluded that the mortgagees’ foreclosure action was not time-barred because the mortgage was filed within twenty years of the creation of the mortgage lien.  The Court cited to I.C. § 32-28-4-1 for the proposition that an action to foreclose a mortgage made to secure payment of money is controlled by a twenty-year statute:

(b)  An action may not be brought or maintained in the courts of Indiana to foreclose a mortgage . . . if the last installment of the debt secured by the mortgage . . . as shown by the record of the mortgage . . . has been due more than ten (10) years.  However, a lien or mortgage described in this section that was created before September 1, 1982, expires twenty (20) years after the time the last installment becomes due, and an action may not be brought to foreclose the mortgage . . . when the last installment has been due more than twenty (20) years.

20 years?  Given the nature of the lien, the Court correctly relied upon I.C. § 32-28-4-1.  But, I’ve been unable to reconcile the Court’s conclusion with the statute’s clear language regarding a ten-year limitations period.  The mortgage in Welch was created after September 1, 1982 (December, 1993 to be exact).  The twenty-year limitations period is limited to mortgages created before September 1, 1982.   

What’s missing?  I do not intend to be critical or otherwise disrespectful to the Court.  Perhaps the opinion does not fully articulate all of the relevant facts, which is not unusual.  For example, the specific terms of the subject mortgage, including when (or whether) the last installment of the debt secured by the mortgage was due, are variables in I.C. § 32-28-4-1(b) not addressed in the opinion.  With the help of my colleague Blaire Henley, the only explanation I’ve been able to come up with relates to Section 2 of I.C. § 32-28-4, which states in relevant part:

if the record of a mortgage or lien . . . does not show when the debt or the last installment of the debt secured by the mortgage or lien becomes due, the mortgage or vendor’s lien expires twenty (20) years after the date on which the mortgage or lien is executed.

Application of I.C.§ 32-28-4-2 gets the Court to the twenty-year limitations period and thus justifies the Court’s ruling in favor of the mortgagees.  (Section 2 was not cited in the opinion, however.)  Please post a comment, e-mail me or call me if you have any knowledge about the Welch case specifically or the Court’s treatment of these statutes generally.  Also, for more on statutes of limitations, please refer to my March 9, 2009 post.  

For purposes of this post, it is important to understand that Indiana has statutes of limitation applicable to many different causes of action, and the limitation periods can be different.  In Welch, the Court properly articulated that the statute of limitations for a mortgage lien suit may be different than a suit based upon a judgment lien.  Although matters like those in Welch will rarely arise in a commercial mortgage foreclosures, secured lenders and their counsel still need to be acquainted with some of these issues, particularly to the extent priority disputes may arise.

Unsigned Cross-Collateralization Agreement Unenforceable In Recent Case

This will supplement my April 5, 2010 post regarding Wells Fargo v. Midland.  If you’re a secured lender struggling with cross-defaulted and cross-collateralized loans, hopefully you have fully-signed agreements clearly capturing the intent of the deal.  Wells Fargo shows what might happen if you don’t. 

Cross-collateralization problems.  One of the two loans at issue in Wells Fargo was not in default.  The borrower thus fought the foreclosure action related to the loan that was current.  The question became whether a non-executed draft of a cross-guaranty, which contained cross-default and cross-collateralization provisions, should have been incorporated into the executed loan documents memorializing two loans.  The subject borrower never executed the cross-guaranty.  Despite that fact, the lender sought to establish that an executed mortgage incorporated the cross-guaranty so as to permit the lender to enforce defaults on both loans.   

Statute of Frauds.  If you have ever heard the term “Statute of Frauds” and wondered what it meant in the foreclosure context, Wells Fargo provides guidance.  The applicable statute in this case is I.C. § 32-21-1-1(b).  Generally, contracts subject to this statute “must be in writing and signed by the party against whom enforcement is sought.”  In Wells Fargo, the cross-guaranty in question was subject to the Statute of Frauds because it was “a promise to answer for the debt of another.” 

Exception to statute?  In Indiana, there are limited circumstances in which an unsigned document can satisfy the Statute of Frauds.  A memorandum satisfying the statute may consist of several writings even though only one writing is signed.  The test is:

The signed instrument must so clearly and definitely refer to the unsigned one that by force of the reference the unsigned one becomes a part of the signed instrument.

Thus the question in Wells Fargo was whether the signed mortgage “so clearly and definitely [referred] to the unsigned cross-guaranty that by force of that reference, the cross-guaranty became a part of the mortgage.”  The Court examined the loan documents and ultimately concluded that they did not satisfy the test. 

Lender Liability Act.  The lender in Wells Fargo got creative with a second theory around the Statute of Frauds that focused on Indiana’s Lender Liability Act, about which I wrote on July 11, 2008.  The lender argued that the conclusion not to enforce the cross-guaranty necessarily meant that the original mortgage had been amended.  Because the ILLA provides that a credit agreement may not be amended without a written agreement, the lender asserted that the signed mortgage must control all the material terms and conditions of the loan, including the alleged cross-collateralization term.  (See I.C. § 26-2-9-5).  But the Court rejected the premise that there was a change and/or revision to the mortgage, stating “that the cross-guaranty provision in the mortgage was, essentially, meaningless” from the start:

When the parties either failed to agree upon the terms of a cross-guaranty, or failed to ensure that the final version was executed, their own conduct resulted in a document that contained a provision referring to a document that did not exist.

Get signatures.  The Court stood firm that the unexecuted cross-guaranty did not survive the Statute of Frauds and that the result did not run afoul of the ILLA.  The obvious lesson here is to make sure all the relevant papers memorializing the terms and conditions of a loan are signed by the appropriate parties.  The absence in Wells Fargo of a signed cross-collateralization agreement, which may have been a simple oversight, prevented the lender from fully enforcing rights that even the borrower may have intended to be a part of the deal.

Next week’s post will explain how the lender’s cross-default/cross-collateralization problem complicated its efforts to have a receiver appointed.

Actual Knowledge Defeats Indiana’s Bona Fide Purchaser Defense Too

The Indiana Court of Appeals, in Weathersby v. JPMorgan Chase Bank, 2009 Ind. App. LEXIS 836 (Ind. Ct. App. 2009) (.pdf) , reminds us that actual knowledge of a prior interest in real estate is just as important as constructive knowledge in disputes over title.

Chronology of events.  On July 24, 1998, the Blair Family Trust (“BFT”) deeded the subject property to Financial Help and Consulting Services (“FHCS”).  That deed was not recorded until November 17, 1998, however.  In the interim, BFT deeded the same property to the 5285 Adams Trust (“5285”), and the BFT/5285 deed was recorded on October 13, 1998, about a month before the recordation of the BFT/FHCS deed.  The point is that, in late 1998, both FHCS and 5285 held a deed to the same property.  By 2000, the 5285 chain of title led to Lewis, who granted a mortgage on the property to Chase.  By 2005, the FHCS chain of title led to Weathersby, who granted a mortgage on the property to MERS.  The Weathersby opinion is about which alleged owner and mortgagee should prevail.

The chain of title split.  The Weathersby suit involved an analysis of the bona fide purchaser doctrine.  In Indiana, in order to qualify as a “bona fide purchaser” one must [1] purchase in good faith, [2] for valuable consideration and [3] without notice of the outstanding rights of others.”  Indiana law recognizes both “constructive” and “actual” notice.  I previously addressed constructive notice on May 28 and June 4, 2009Weathersby focused on actual notice and examined the effect of BFT’s 1998 conveyances of the property to both 5285 and FHCS.  Chase’s contention was that the July 24, 1998 deed to FHCS did not provide notice to 5285 because BFT did not record the deed until November 17, 1998, a month after the BFT/5285 deed was recorded.  The Court of Appeals agreed that, under I.C. § 32-21-4-1, 5285 did not have constructive notice of the deed to FHCS, but the compelling question was whether 5285 had actual notice of the deed. 

Test for actual notice.  Indiana law provides that, “notice is actual when notice has been directly and personally given to the person to be notified.”  Actual notice may be implied or inferred:

[f]rom the fact that the person charged had means of obtaining knowledge which he did not use.  Whatever fairly puts a reasonable, prudent person on inquiry is sufficient notice to cause that person to be charged with actual notice, where the means of knowledge are at hand and he omits to make the inquiry from which he would have ascertained the existence of a deed or mortgage.  Thus, the means of knowledge combined with the duty to utilize that means equates with knowledge itself.  Whether knowledge of an adverse interest will be imputed in any given case is a question of fact to be determined objectively from the totality of the circumstances.

Need for trial. The Court in Weathersby reversed the summary judgment granted to Chase and remanded the case for trial because there were factual issues surrounding the role of attorney Michael Delfine.  Mr. Delfine’s fingerprints are all over the key transactions.  Because the evidence at the summary judgment stage was not entirely clear, the Court of Appeals remanded the case for trial.  Here’s how the Court articulated the unresolved issues:

This evidence demonstrates that Delfine was aware that the Property had been transferred to both FHCS and [5285] in 1998.  In June 1999, Delfine was identified as the trustee of [5285].  However, the designated evidence does not demonstrate whether Delfine was also the trustee of [5285] in October 1998 or whether Delfine’s knowledge would be [legally] imputed to [5285].  As a result, we conclude that genuine issues of material fact exist regarding whether [5285] had actual knowledge in October 1998 of the prior transfer from [BFT] to FHCS and, thus, whether [5285] was a bona fide purchaser of the Property.

If 5285 was not a bona fide purchaser, then the chain of title leading to Lewis and Chase must fail, in which case Weathersby/MERS would prevail.

Weathersby demonstrates that, in the absence of constructive notice of a deed or mortgage, actual notice can be outcome determinative in title disputes.  Admittedly, litigation surrounding chain of title in commercial foreclosure cases is rare.  Cases like Weathersby mainly arise out of residential transactions.  Further, Weathersby appears to be unique in terms of the role of Mr. Delfine, and the Court noted that he resigned from the Indiana bar in 2002.  In the end, like many of these cases, the over-arching message for lenders is that it’s very important to have a closing that is covered by title insurance. 

What Does “Chain Of Title” Mean?

The Indiana Court of Appeals in Weathersby v. JPMorgan Chase, 2009 Ind. App. LEXIS 836 (Ind. Ct. App. 2009) (.pdf), which I’ll discuss in more detail next week, explains the idea of “chain of title” and what it means in Indiana.  To brush up on your real estate vocabulary, keep reading.

Chain of title.  Weathersby explains what “chain of title” to a tract of land is.  Here are the Court’s words:   

 In a title search, the prospective purchaser or his abstractor assesses the marketability of title to a tract of land by determining the “chain of title.”  Beginning with the person who received the grant of land from the United States, the purchaser or abstractor traces the name of the grantor until the conveyance of the tract in question.  The particular grantor’s name is not searched thereafter.  As the process is repeated, the links in the chain of title are forged.

My trusty Black’s Law Dictionary defines “chain of title” as:

 Successive conveyances, or other forms of alienation, affecting a particular parcel of land, arranged consecutively, from the government or original source of title down to the present holder.

Indiana’s system.  Indiana counties are required to maintain a name index system for recording deeds and mortgages.  See, Ind. Code § 36-2-11-12.  These indices are organized alphabetically by grantor and by grantee, or mortgagor and mortgagee, with cross-references.  Furthermore, the indices describe the tract and show the date of the recording.  As noted in Weathersby, purchasers of real estate are presumed to have examined these county records and are legally charged with notice of the facts in them.  This rule applies to both purchasers and mortgagees.  A record outside the chain of title does not provide constructive notice to bona fide purchasers for value, however. 

Following a chain of title is sort of like connecting the dots of ownership.  As I’ll illustrate in next week’s post, there are times when parties, outside the chain of title, claim an interest in, or ownership to, real estate.  Weathersby addresses what can happen in such a scenario.

BFP Defense Denied, And IRS Lien Prioritized

Last week’s post dealt with the successful application of the bona fide purchaser (“BFP”) doctrine in connection with the Kumar case.  This week’s post illustrates the opposite result, rendered by U.S. District Court Judge Barker in CitiMortgage, Inc. v. Sprigler, 2009 U.S. Dist LEXIS 27866 (S.D. Ind. 2009) (CitiMortgage.pdf).  Among other things, CitiMortgage shows secured lenders that, in Indiana, a recorded mortgage runs with the land and should be enforceable regardless of any subsequent transfers of the real estate.  The opinion also generally addresses the relative priorities of mortgage liens and IRS liens. 

What happened.  Borrowers signed a $300,000 promissory note and executed a mortgage on the subject real estate to secure the note.  The lender recorded the mortgage on April 2, 2002.  The borrowers later conveyed the property by warranty deed for “the sum of One Dollar ($1) and other good and valuable consideration” to Sprigler (a relative), who recorded the deed on November 30, 2005.  Sprigler did not assume the mortgage in the transaction.  The borrowers failed to make payments and therefore defaulted under the note and mortgage.  The default prompted the lender to initiate the mortgage foreclosure case. 

BFP?  My May 27 post outlines the elements of the bona fide purchaser doctrine, which Sprigler used to oppose the lender’s motion for summary judgment in CitiMortgage.  Sprigler contended that he “took in good faith believing that the real estate was being conveyed to him free and clear of all liens.” 

As the Indiana Court of Appeals did in Kumar, Judge Barker in CitiMortgage turned to Ind. Code § 32-21-4-1, which she labeled the “Race-Notice Statute.”  In Indiana, the question of priority as it relates to a good faith purchaser generally is governed by that statute.  Unlike in Kumar, the BFP defense didn’t fly in CitiMortgage.

“Race-Notice” statutes give all parties an incentive to record their interests in the subject property.  Under the Indiana statute, a subsequent purchaser (Sprigler) cannot obtain priority if he knew about the mortgage to the first mortgage holder (CitiMortgage), or if he lost the “race” to record his interest.  In the case at bar, Sprigler claims that he did not know about CitiMortgage’s mortgage.  While this may be true, the facts clearly demonstrate that he lost the race to record.  CitiMortgage recorded its mortgage on April 2, 2002.  Under Indiana’s Race-Notice statute, Sprigler was constructively on notice of CitiMortgage’s interest when he recorded his interest on November 30, 2005.  Thus, CitiMortgage’s interest has priority over Sprigler’s interest, and CitiMortgage is entitled to summary judgment.

Mortgagee protected.  In Kumar, there was no notice due the failure to timely record a tax deed.  In CitiMortgage, there was notice because the lender properly and timely recorded its mortgage.  One of Kumar’s lessons was “don’t forget to record the deed.”  One of CitiMortgage’s lessons is “don’t forget to record the mortgage.”  Although not expressed in the CitiMortgage opinion, clearly Sprigler failed to search title before acquiring the real estate.  The lender adequately protected itself by recording its mortgage.  Had it failed to do so, the BFP doctrine may have negated the mortgagee’s interest in the property. 

IRS lien.  As an aside, the United States of America had interests in the property arising out of IRS liens and thus was named as a defendant in the case.  The IRS filed notices of liens beginning on March 17, 2004, after the lender recorded its mortgage on April 2, 2002.  In response to the lender’s summary judgment motion, the United States sought the recognition of its liens and their priorities.  Specifically, a foreclosure decree must spell out the right of redemption of the United States contained in 28 U.S.C. § 2410(c).  Pursuant to Indiana’s recording statute, a/k/a the race-notice statute, the IRS lien interests have priority “according to the time of the filing thereof.”   Because the lender’s mortgage interest had first priority in the property, the liens of the United States were subordinate.  However, per § 2410(c), the United States retained a right of redemption for 120 days from the sheriff’s sale.  For more on liens of the United States, study 28 U.S.C. § 2410.

Don’t Forget To Record The Deed

The Indiana Court of Appeals in Kumar v. Bay Bridge, 2009 Ind. App. LEXIS 507 (Ind. Ct. App. 2009) (.pdf) explained what might happen if one purchases real estate but fails to record the deed.  In Kumar, prior owner, INB National Bank Trust, had not paid property taxes for years.  Mr. Kumar acquired the subject real estate at a tax sale but didn’t immediately record the tax deed.  After the tax sale, the successor-in-interest to the Trust conveyed the property to Bay Bridge, which recorded the trustee’s deed shortly thereafter.  Bay Bridge later discovered that Kumar claimed an interest in the property.  Bay Bridge filed a complaint to quiet title to the real estate and named Kumar as a defendant.  In response, Kumar quickly recorded his tax deed, but the Court held it was too late.

The recording statute.  Ind. Code § 32-21-4-1 provides that deeds must be recorded in the Recorder’s Office of the county where the land is situated and, furthermore, that a conveyance “takes priority according to the time of its filing.”  The purpose of this so-called recording statute “is to provide protection to subsequent purchasers, lessees and mortgagees.”

Bona fide purchaser doctrine.  Because Kumar failed to record his tax deed as required by I.C. § 32-21-4-1, Bay Bridge did not have notice of Kumar’s interest when it purchased the property.  In the lawsuit, Bay Bridge argued for the application of Indiana’s bona fide purchaser doctrine with respect to Kumar’s claim to ownership of the real estate.   The Court of Appeals stated the general rule that “to qualify as a bona fide purchaser, one has to [1] purchase in good faith, [2] for valuable consideration, and [3] without notice of the outstanding rights of others.”  This acts as a defense to title, and the theory “is that every reasonable effort should be made to protect a purchaser of legal title for a valuable consideration without notice of a legal defect.” 

Notice.  There was no question Bay Bridge was a purchaser in good faith for valuable consideration.  The only issue was whether it was without notice of Kumar’s interest.  In Indiana:

 A purchaser of real estate is presumed to have examined the records of such deeds as constitute the chain of title thereto under which he claims, and is charged with notice, actual or constructive, of all facts recited in such records showing encumbrances, or the non-payment of purchase-money.  A record outside the chain of title does not provide notice to bona fide purchasers for value.

Kumar failed to record, so Bay Bridge wasn’t deemed to have notice.  Also, there was evidence in Kumar that, before purchasing the property, Bay Bridge had requested a title search and found nothing with regard to the tax sale or Kumar’s tax deed.

Unfortunate, but understandable, result.  The Court of Appeals affirmed the trial court’s summary judgment in favor of Bay Bridge on its complaint to quiet title.  The Court wiped away Kumar’s interest in the property.  Had Kumar simply recorded the tax deed, there never would have been a issue.  The Kumar case is a reminder for foreclosing lenders and their counsel to record the sheriff’s deed following a sheriff’s sale, or any deed executed in connection with a deed-in-lieu of foreclosure.  Bizarre problems like the one illustrated in Kumar are rare but can arise in connection with a commercial mortgage foreclosure.  Moreover, secured lenders need to be aware of the bona fide purchaser doctrine should unexpected claims to title arise during or after the foreclosure process. 

Termination Of Mortgages In Indiana

As promised, this post will speak to the second issue in the Bank of America case that was the subject of my February 15 post.  This discussion will help secured lenders who may struggle with knowing whether Indiana law permits the release of a prior mortgage when such mortgage secured a revolving line of credit that has been paid in full.

Contracts and performance.  Due to the importance of the language in the 1999 Bank One mortgage, I must outline it here:

[W]ithout limitation, this Mortgage secures a revolving line of credit, which obligates [Bank One] to make future obligations and advances to [borrower] up to a maximum amount of $ 80,000.00 so long as [borrower] complies with all the terms of the Credit Agreement.  . . .  It is the intention of [borrower] and [Bank One] that this Mortgage secures the balance outstanding under the Credit Agreement from time to time from zero up to the Credit Limit as provided above and any intermediate balance.  . . .

PAYMENT AND PERFORMANCE. Except as otherwise provided in this Mortgage, [borrower] shall pay to [Bank One] all amounts secured by this Mortgage as they become due, and shall strictly perform all of [borrower's] obligations under this Mortgage.  . . .

FULL PERFORMANCE.  If [borrower] pays all the indebtedness when due, terminates the Credit Agreement, and otherwise performs all the obligations imposed upon [borrower] under this Mortgage, [Bank One] shall execute and deliver to [borrower] a suitable satisfaction of this Mortgage and suitable statements of termination of any financing statement on file evidencing [Bank One's] security interest in the Rents and the Personal Property. [Borrower] will pay, if permitted by applicable law, any reasonable termination fee as determined by [Bank One] from time to time.  . . .

In 2001, when a portion of the proceeds from the Bank of America loan was used to pay the entire outstanding balance of the Bank One loan, Bank One did not send “correspondence or instructions” to Bank of America or the borrower.  In addition, neither the borrower nor Bank of America took action to terminate the Bank One credit agreement. 

The fight.  The litigation surrounded whether the prior Bank One mortgage had priority over the subsequent Bank of America mortgage.  Bank of America contended that, under I.C.§ 32-28-1-1(b), it was entitled to a release of the Bank One mortgage because Bank of America discharged the debt underlying that mortgage and, furthermore, because that mortgage was ambiguous as to whether written notice of termination by the mortgagor was required for the mortgage to be released.  I.C. § 32-28-1-1(b) states, in pertinent part:  “When the debt . . . on . . . the mortgage . . . has been fully paid, lawfully tendered, and discharged, the owner, holder, or custodian shall:  (1) release; (2) discharge; and (3) satisfy of record; the mortgage . . ..”  The Court concluded that the Bank One mortgage stated three requirements for “full performance:”  (1) borrower must pay all the indebtedness when due, (2) borrower must terminate the credit agreement and (3) borrower must perform all other obligations.  Each of those three was required of the borrower before Bank One was obligated to release the mortgage. 

Bank One the winner.  It was undisputed that, even though the indebtedness under the mortgage had been paid, the borrower took no affirmative action to terminate the credit agreement.  As a result, the Court held that Bank One was not required to release its lien on the real estate.  Bank of America complained that the Bank One mortgage did not require written notice of termination and that Bank One failed to notify the borrower or Bank of America what act was required to terminate the credit agreement.  The Court rejected the argument and reasoned that the Bank One mortgage “clearly require[ed] some affirmative act of termination.  . . .  The Bank One mortgage required [borrower] to terminate the Credit Agreement; Bank One did not need to reiterate to [borrower] her contractual obligations.”

Always follow-up.  The important court holding here is that “absent documentation to the contrary, we decline to hold that merely to pay off an outstanding balance is sufficient to terminate a revolving line of credit, as that would violate the very nature of the credit.”  Unlike a mortgage securing a term note, the Bank One mortgage secured a revolving line of credit that contemplated future advances, regardless of whether there was an occasional zero balance. 

Secured lenders operating in Indiana, particularly those involved in refinancing, need to be aware that, if confronted with facts similar to the Bank of America case, merely paying off a line of credit may be insufficient in itself to terminate a prior note/credit agreement/mortgage.  So, review and analyze the loan documents and ensure you jump through all the hoops to terminate the prior transaction and lien.  Otherwise, you may be faced with an unexpected subordinate lien position.

Inattention To Detail: Another Lesson In Mortgage Loan Documentation

Judge Philip Klingeberger of the U.S. Bankruptcy Court for the Northern District of Indiana addressed a unique situation in In Re Canaday, 2007 Bankr. LEXIS 3121 (N.D. Ind. 2007) (CanadayOpinion.pdf).  The loan transaction involved a note, which identified the holder to be a trust (the Don Wilson Revocable Living Trust), and a mortgage, which identified the mortgagee to be an individual (Don Wilson).  The 19-page opinion provides an impressive summary of various Indiana mortgage laws and illustrates once again the consequences of sloppy transactional work.    

The problem.  Debtor Canaday, the owner of real estate, executed a note in favor of the Wilson Trust and, contemporaneously, a mortgage in favor of Don Wilson, individually.  So, the Wilson Trust held the note, but Wilson individually held the mortgage.  (It also bears mentioning that the mortgage referred to a January 12 note, but the date of the note was January 13.)  When the debtor filed bankruptcy, Don Wilson, as a creditor, filed a secured claim in the bankruptcy case.  The debtor objected to the secured status of the claim and asserted that the mortgage was invalid.  The issue was whether the mortgage was effective against a hypothetical bona fide purchaser under 11 U.S.C. § 544(a)(3)Canaday at 5. 

Gap in the law.  According to Judge Klingeberger:

  [T]here is an amazing, incredible lack of case law on the issue
  of the validity of a mortgage – both in relation to the parties to
  that instrument and in relation to third parties potentially having
  interests in the real estate subject to the mortgage – in a
  circumstance in which no indebtedness is owed in any manner
  to the designated mortgagee. 

Id. at 11.  The absence of case law probably has to do with the unique set of facts.  How often, if ever, would a lender execute loan documents in which the lender’s name in the note and the mortgage was not identical?  Judge Klingeberger sidestepped the opportunity to create new law as to this issue but instead based his holding on more settled principles.   

Indiana’s mortgage statutes.  The rules upon which the Judge primarily focused can be found in two Indiana statutes, Indiana Code § § 32-21-4-1 and 32-29-1-5

     I.C. § 32-21-4-1, Indiana’s recording statute, generally provides that constructive notice sufficient to defeat the interests of a bona fide purchaser is given only if the mortgage is recorded.  Canaday at 9.  The purpose of the recording statute is to give subsequent purchasers constructive notice of a prior conveyance.  Id.  “Constructive notice” means “a legal inference from established facts.”  Id. at 10.  For example “deeds and mortgages, when properly acknowledged and placed on record as required by statute, are constructive notice of their existence.”  Id.  “Actual notice” means that a party actually knows, for instance, of the existence of a mortgage.  In instances of constructive notice, a party may not actually know of a fact but is deemed to know it.

     I.C. § 32-29-1-5, the second statutory piece of the puzzle, defines both the elements of a mortgage that is valid between the mortgagor and the mortgagee, and – in conjunction with I.C. § 32-21-4-1 – also defines the requirements for a mortgage to be valid against a bona fide purchaser of the subject property from the mortgagor.  Canaday at 10.  At issue in Canaday were requirements surrounding the description of the indebtedness.  “Indiana has a long line of cases which cogently define the elements of the description of an indebtedness in a mortgage which caused that mortgage to be valid both between the parties, and with respect to third persons . . ..”  Id. at 13.  Judge Klingeberger ultimately concluded that the indebtedness description in the mortgage instrument, for purposes of giving rise to a secured claim, was insufficient:

Indiana case law … requires far more than the mortgage instrument at issue in this case provides in order to sustain the validity of that mortgage against a bona fide purchaser.  The mortgage instrument in this case does not direct an individual reviewing the real property records with respect to the subject real estate to an individual who can be assumed, based upon this record, to have knowledge as to the indebtedness secured by the mortgage.  The mortgage instrument in this case describes a promissory note which does not exist – there is simply no evidence of any obligation evidenced by a promissory note dated January 12, 2005, and the mis-description of the date of the actual note evidencing the underlying obligation secured by the mortgage creates exactly the situation in which Indiana case law seeks to avoid with respect to substitution of indebtedness.  In similar manner, even apart from the erroneous designation of the date of the promissory note, there is insufficient information in the mortgage to clearly identify the indebtedness to which it relates.  Finally, there is no statement in the mortgage of “the date of the repayment” of the indebtedness which the mortgage purports to secure.

Id. at 18-19 (emphasis in original). 

Canaday is another example of the consequences of inattention to detail in the preparation of loan documents.  The creditor’s secured claim was relegated to an unsecured claim with significantly less value, if any value at all.  It’s hard for lien enforcement lawyers like me to meet the needs of banking clients when the underlying loan documents are flawed.  Remember – enforcement of a creditor’s rights begins when the parties initially draft the docs. 

Technical Errors In Mortgage Language May Not Be Fatal

On August 2, 2007, Judge Philip Simon of the Northern District of Indiana, Hammond Division, issued an opinion about the impact of a mortgage that incorrectly defined the borrowers.  See, In Re:  Camp, 2007 U.S. Dist. LEXIS 57292 (N.D. Ind. 2007) (CampOpinion.pdf).  Judge Simon’s opinion discusses some of the general rules applicable to Indiana mortgage instruments, and there are lessons to be learned from the case.

Background.  Only husband signed the note.  But, both husband and wife executed the mortgage as “borrowers.”  Husband subsequently filed a Chapter 13 petition for bankruptcy, and the assignee of the note and mortgage filed a secured claim in the bankruptcy proceeding.  Husband-debtor argued that the secured claim should be avoided because the mortgage was invalid.  He wanted the property to be free and clear of all liens.  The legal basis of his argument was that the mortgage did not sufficiently describe the debt it purported to secure. 

Bankruptcy context.  11 U.S.C. § 544(a)(3) governed the ruling.  The two specific issues were (1) whether the debt was adequately described in the mortgage and (2) whether the mortgage provided constructive notice to a bona fide purchaser as required by federal bankruptcy law.  (11 U.S.C. § 544 (a)(3) is known as the “strong-arm statute”.)  Generally, an encumbrance can be avoided if a bona fide purchaser would not have constructive notice of it.

Indiana mortgage laws.  Here are some of the relevant Indiana statutes and common law rules:

1.  Ind. Code § 32-21-4-1 provides that constructive notice is given by a properly-recorded instrument.

2.  I.C. § 32-21-2-3 states that a mortgage must be acknowledged by the grantor to be recorded.

3.  I.C. § 32-29-1-5 sets forth the requirement for a form mortgage.  Among other things, the mortgage must describe the debt sought to be secured, and it must be dated and signed, sealed and acknowledged by the grantor. 

4.  The mortgage must be properly acknowledged and recorded to provide constructive notice to subsequent purchasers.  The mortgage must be recorded in the proper county and must contain an accurate legal description of the property. 

5.  The mortgage must be in the chain of title.

6.  In Indiana, the recording of a document not entitled to be recorded (due to statutory violations) does not afford constructive notice.  Exceptions to this general rule could include, for instance, a mortgage that omits the preparer’s name.  Although technically in violation of I.C. § 36-2-11-15(b) , constructive notice is still afforded because the defect “was not one which would have been fatal to a conveyance or encumbrance.  Thus, a title searcher wishing to verify the legal title of the property would have found all the formalities necessary to prepare a valid conveyance or [encumbrance].”  Camp at 8.

Camp technicality.  The mortgage indicated that husband and wife collectively were the “borrower.”  Actually, only husband executed the note.  This error breached the statute requiring a proper description of the debt.  I.C. § 32-29-1-5.  The question for the Court in Camp was whether this statutory violation defeated constructive notice or whether it was, in the final analysis, immaterial.  Here is what a prior Indiana opinion stated:

  The description in the mortgage of the indebtedness secured
  need not be literally accurate, but must be correct so far as it
  goes, and full enough to direct attention to the sources of correct
  information in regard to it, and be such as not to mislead or
  deceive, as to the nature or amount of it, by the language used.

Pioneer v. First Merchants, 349 N.E.2d 219, 222 (Ind. Ct. App. 1976). 

The mortgage in question “complied with almost all of Indiana’s statutory requirements.”  Camp at 9.  It expressly stated that an encumbrance (by virtue of the note) existed on the property.  The Court found that “any bona fide purchaser would have constructive notice of the existence of the Note and its amount - - the most important aspects of the debt - - even if the defined executor of the Note was incorrect.”  Id.  The Court further concluded that a bona fide purchaser then would have a duty to inquire into the substance of the note and, ultimately, would find that the note and the mortgage were signed on the same day, stated the same amount, described the same lender and included the same repayment date.  Accordingly, the mortgage passed the operative test:  a proper examination of the record would have led a reasonable man to conclude that the property to be mortgaged was subject to a prior encumbrance.  As such, the husband-debtor’s objection to the mortgage lender’s secured claim was overruled.

Be careful.  Sometimes technical errors will be fatal.  Sometimes they won’t.  Fortunately for the lender in Camp, other accuracies in the loan documents trumped the isolated inaccuracy.  Despite the ultimate victory, however, it appears much time and effort went into litigating the issue.  Aside from the obvious lesson that not all language errors will be fatal to a mortgage lien, perhaps a more important lesson is that the loan documents on the front end of a deal should be perfect.  Time and legal fees would have been saved had the borrower been described properly.  A simple, innocent oversight I’m sure, but a costly one nonetheless.


An interesting dispute in the United States Bankruptcy Court for the Northern District of Indiana resulted in a March 27, 2007 opinion by Judge Harry C. Dees, Jr. about a borrower’s attempt to transfer ordinance citations, fines and other property-related liabilities to a lender.  The issue was whether a mortgagor’s/borrower’s unilateral execution and recordation of a quit-claim deed effectively transferred the real estate to the mortgagee/lender.  Although the case involved residential property, the rules and holding are equally applicable to commercial real estate and business borrowers.  The lesson of Phillips v. City of South Bend, 2007 Bankr. LEXIS 1503 (N.D. Ind. 2007) is:  a borrower simply can’t unload its real estate-based problems onto a secured lender without some kind of agreement or consent.  (PhillipsOpinion.pdf).   

The facts.  The City of South Bend pursued a residential property owner for nuisance violations related to property, which was in disrepair and had documented unsanitary conditions in the yard.  Potential fines and penalties were around $5,000.  Citifinancial held a mortgage on the property.  The borrower/mortgagor, in an apparent effort to avoid municipal liability, executed and recorded a quit-claim deed purporting to abandon the property and transfer title to Citifinancial.  Citifinancial, however, never “acknowledged transfer of the property” or took “responsibility for maintaining the property.”  Id. at 3.  Citifinancial “did not accept the transfer” (although it is not entirely clear how Citifinancial manifested that non-acceptance).  The borrower did not enter into any kind of written agreement with Citifinancial, and Citifinancial “took no action at all” with regard to the property.  Id. at 14.  There was no written consent by Citifinancial or any activity demonstrating consent, such as the physical possession of the property.  Evidently, Citifinancial simply ignored the quit-claim deed.

Indiana mortgages, generally.  Indiana follows the “lien theory” of mortgages.  This means that a mortgage creates a lien on property but not title to it.  Mortgagees do not have an ownership interest in the real estate.  Id. at 15.  Title to property cannot be transferred to the mortgagee unless there is a foreclosure and sale (or a deed-in-lieu of foreclosure).  Indiana defines “foreclosure” as a legal proceeding that terminates a mortgagor’s interest in property.  Id.  “The right to possession, use and enjoyment of the mortgaged property, as well as title, remains in the mortgagor, unless otherwise specifically provided, and the mortgage is a mere security for the debt.  Id.  So, secured lenders holding Indiana mortgages merely have liens as security for their loans.

Transfer is a two-way street.  In Phillips, the borrower executed and recorded a quit-claim deed in order to surrender the property, but no foreclosure took place.  The Court held that the borrower could not compel the mortgage holder to accept the surrendered, quit-claimed property and that the borrower continued to be the owner of the property, with all the rights and obligations.  The City properly enforced its property maintenance codes against the borrower, not the lender, as owner of the property.  Id. at 15.  The unilateral execution of a quit-claim deed in an effort to surrender the property to mortgage holder, while clever, ultimately accomplished nothing from the standpoint of avoiding liability. 

Impact on commercial cases.  Phillips impacts the handling of commercial foreclosure cases as well.  A corporate borrower in possession of commercial real estate collateral could decide, in an effort to avoid certain liabilities related to the ownership of the land (such as public nuisance fines, utility charges or maybe even real estate taxes), to dump these problems back on a commercial lender simply by quit-claiming the property and surrendering possession.  A secured lender may, for a variety of reasons, not want the property, particularly by quit-claim deed, until the property is run through a foreclosure.  In that case, according to Phillips, the secured lender should take every possible action to show that it has not acknowledged or accepted transfer of the property or otherwise consented to ownership.  Don’t sign any paperwork indicating you are the owner.  Avoid physical presence on the premises.  Make sure there are no communications with the mortgagor/borrower other than with statements that unequivocally demonstrate you do not want title to the property at that time (unless through a deed-in-lieu of foreclosure with a supporting agreement).  That way, if and when you want to liquidate the collateral or become the owner of the property, you can do it on your own terms and avoid the potential liability found in Phillips.